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

Thank you for standing by, and welcome to the HomeCo Daily Needs REIT FY '23 Full Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Sid Sharma, HDN's CEO. Please go ahead.

Good morning, and thank you all for joining us today. On the call today with me is HMC Group CFO, Will McMicking; and HDN Fund Manager, Paul Doherty. Before we commence today's presentation, we would like to acknowledge the traditional custodians of country throughout Australia. We celebrate the diverse culture and connections to land, sea and community. We pay our respects to their elders, past and present, and extend that respect to aboriginal and Torres Strait Islander people today. We'll turn to Slide 4 and commence the presentation. FY '23 has been a solid year for HDN, with strong operational performance underpinned by a strengthened balance sheet. We have dealt with the unique macro landscape by focusing on top line revenue and prudent expense management. We have delivered on our earnings guidance for FY '23 and have a solid platform to sustained earnings through FY '24. The structural megatrend, which sees our assets increasingly become essential last mile retail logistics hubs, is what underpins our performance and growth. Our assets are in the best growth suburbs of Australia. These assets remain in high demand, from tenants and investors. Through the period, we recycled $285 million of assets at a 3% premium to our previously stated book values. The convenience retail asset class is very unique, and so is our portfolio. It is on that basis that HDN successfully delivered on FY '23 FFO per unit guidance of $0.086 and distribution of $0.083. This was made possible by a very strong set of operational results, underpinned by 99% occupancy, 99% cash collection, 3.8% comp NOI growth, 6% sector-leading re-leasing spreads. NTA per unit was $1.48 represents only a minor decrease from the half year, with strong NOI growth partially offsetting cap rate softening recorded across the portfolio. We are currently targeting to commence over $120 million of development projects in FY '24 aiming to deliver 7% ungeared cash-on-cash returns. Through the period, we undertook a number of strategic and proactive capital recycling initiatives. We announced approximately $143 million of accretive acquisitions, including the purchase of Southlands Boulevard and investment in the Last Mile Retail Logistics Fund, both of which we have fully funded through capital recycling initiatives. Pleasingly, the $285 million of assets we disposed of were sold at a combined 3% premium to their prevailing book values, highlighting the quality of our portfolio and our valuation. The balance sheet remains in a strong position, with gearing of 32.8% at the lower end of HDN's target range. Interest rate risk has been mitigated with approximately 92% of drawn debt hedged until FY '25. On Slide 5, we summarize HDN's investment strategy, which remains unchanged. We continue to target a model portfolio of 50% neighborhood, 30% large format retail and 20% health and services tenants across our network. This mix balances the best characteristics of defensive, reliable income streams with sustainable growth. HDN's strong investment fundamentals are underpinned by low rents set at the bottom end of the landlord cost curve, sector-leading re-leasing spreads and high exposure to national retailers. This is translating into 99% cash collections and 6% leasing spreads for the period. HDN owns over 2.5 million square meters of high-quality and strategically located property, with just 37% site coverage. This gives us substantial opportunity to leverage the rapidly emerging and essential last-mile infrastructure trends to unlock additional embedded value. Our portfolio is differentiated. 83% of our assets are in metropolitan locations with a high skew to the large growth centers of Sydney, Melbourne, Brisbane to the Gold Coast. We serve over 13 million Australians, who live within a 10-kilometer radius, and have over 83 million visitations through our assets per annum. As a result, our assets increasingly serve a critical role in our tenant's omnichannel retailing strategies. I will now hand over to Paul Doherty for the portfolio update.

Thanks, Sid. Turning to Slide 7. HDN owns $4.7 billion of high-quality real estate occupied by more than 1,200 tenants. 71% of the income has a weighted average fixed rent review of 3.6%, and 21% of our income has annual increases linked to CPI. HDN's sustainable rents of just $357 per square meter and customer convenience provide a reliable platform for growth for our tenants and for investors. Moving now to Slide 8. HDN's high occupancy of above 99% and cash collections that continued to exceed 99% each month throughout FY '23 underscores the portfolio's weighting to high-quality assets and robust tenant profiles. We have continued to proactively remix the tenant base to increase exposure to more defensive daily needs-focused retailers and maintaining high exposure to national operators. In FY '23, we recycled approximately 3% of tenants into nondiscretionary and stronger covenant retailers. In addition, we have already leased approximately 50% of FY '24 expiring income. This has resulted in only 6% of total income expiring over the remainder of FY '24. We achieved this improvement and continue to grow HDN's property income with 174 leasing deals completed in the year, delivering positive spreads of 6% and maintaining low incentives of just 5.3%. Footfall remains elevated post-COVID and customers are increasingly living, working, shopping and dining closer to home in the fastest-growing suburbs of Australia. Visitation across our real estate is running at an annualized 83 million customers per annum, representing comparable growth of more than 20% against FY '20. As a result, HDN's retailers continue to perform strongly, with total moving annual turnover growth of 4.9% for the year. On Slide 9, we provide further detail about our top tenants and portfolio weightings, currently which, as I said, we are rebalancing to be in line with the target portfolio weightings at the time. Sid will now take you through our FY '23 sustainability achievements.

Thank you, Paul. On Slide 10, I'm pleased to report on the progress of our sustainability objectives across HDN. As many of you know, to meet our 2028 net zero target, we have a 3-stage program on energy reduction. The program remains on track and we're really proud of our energy systems rollout that is well-progressed. Many of you know, our energy management system upgrade to convert our buildings to smart buildings is well-progressed, and I'm pleased to report we now have 27 sites with this installation now complete. This is generating a 23% like-for-like reduction in energy consumption reported today. In addition, 10 sites across their HomeCo Daily Needs REIT now have solar installations, with another 5 sites currently being installed today. The next phase will see the rollout across the balance of our network, and these stages are both very critical for us to achieve our net zero target within our asset base. Moving to Slide 13 and the growth opportunities for HDN. On Slide 13, we summarize the significant value we have created through development since IPO. In just over 2 years, HDN has completed over 16 developments and committed over $160 million of development projects, which have delivered to date a 9% cash-on-cash return. Our track record further builds on the team's capability in successfully repositioning over 500,000 square meters of GLA since acquiring the Masters portfolio in 2017. Looking forward, our land bank spanning 2.5 million square meters provides compelling long-term upside via relatively low-risk tenants' demand-led projects. Slide 14 highlights our development pipeline, which we upscaled earlier this year. It underscores in more detail the substantial embedded growth opportunity in the portfolio which we believe is the key differentiator for HDN to its peers. Not only does the development pipeline remain a key pillar for the group, it continues to offer compelling risk-adjusted returns, is accelerating HDN's tenant remixing towards defensive daily needs tenants, and most importantly, it is tenant demand led, as highlighted by our FY '23 commencements, which were all 100% precommitted project. Turning to Slide 15, HDN commenced over $80 million of accretive development projects in FY '23, which we expect to deliver a cash-on-cash return of over 7%. South Nowra completed in the second half of FY '23, and we expect the 2 large projects at Glenmore Park and Mackay to complete in the second half of FY '24. Pleasingly, all of these projects are 100% precommitted. Slides 16 and 17 provide further detail on our progress, and all projects, as you will see, have an excellent mix of high-quality national tenants and household brands. All projects remain on track to timing and on budgeted costs. On Slide 18, we've highlighted some of our FY '24 development opportunities. To help and support unlock the development pipeline, we're aiming to commence over $120 million development projects throughout the year. We continue to target over a 7% cash-on-cash return. We have multiple development opportunities at various stages of planning that will fall into the $120 million of commencements, subject, of course, to achieving the appropriate level of returns. I will now hand over to Will to provide some commentary around the financial results.

Thanks, Sid. Turning now to Slide 20 to go through the earnings summary. Property NOI grew to $261 million in FY '23, which was driven by the full year impact of the Aventus merger, which completed in March '22. Pleasingly, underlying property revenue growth in FY '23 offset higher property and interest expenses. Overall, HDN recorded FY '23 FFO of $177 million or $0.0086 per unit, with the latter representing 12% compound annual growth since inception. Turning now to the balance sheet on Slide 21. HDN has a robust balance sheet at June '23, with net assets of $3.1 billion and gearing at 33.8%. June '23 NTA was $1.48 per unit, recording a modest 3% reduction versus June '22, which was driven by an increase in the portfolio cap rate from 5.3% to 5.5%. The resilience of the property portfolio has enabled active asset recycling, with the divestment of noncore properties, Sunshine and Epping in FY '23 at a premium to book value and the acquisition of Southlands and HDN's investment into the Last Mile Logistics Fund. HDN will continue to leverage its balance sheet, undertake asset recycling and fund organic growth into FY '24 and is recently evidenced by the contracted sale of the Midland LFR Center. Moving to Slide 22 to talk to capital management. June '23 gearing of 33.8% is at the lower end of the target range, and adjusted for the recently contracted sale of Midland, reduces by 1% to 32.8%. Hedge debt increased to 92% at June, following a noncash restructure in the fourth quarter of FY '23, which provides strong interest rate protection into FY '24 and FY '25. And combined with liquidity of $270 million post the Midland sale and low gearing puts HDN in a strong position for FY '24. I will now hand back to Sid.

Thanks, Will. Turning to our outlook and guidance. We're pleased today to provide FY '24 FFO guidance of $0.086 per unit and distribution per unit guidance of $0.083. Our relatively positive outlook is underpinned by the following: Firstly, our strong operating metrics reflect our high weighting to nondiscretionary retail and the best metropolitan locations where tenant demand remains robust. This is resulting in underlying NOI growth, which is offsetting the impact from higher interest rates and property costs. Secondly, we continue to successfully execute on our $600 million development pipeline, which remains a key growth pillar. And finally, we are well capitalized to fund our development pipeline. Our management and Board remain disciplined and focused as we have always done. We are committed to funding growth out of the existing capital base and maintain conservative gearing in our target range. Thank you. And I will now open the line up for questions.

[Operator Instructions] The first question today comes from Sholto Maconochie from Jefferies.

Just a couple of questions. I couldn't quite see them, you maybe changed your methodology, but the sales figure, the MAT growth, you used to report supermarket and other excluding supermarkets. So for example, it was 2.7% supermarkets at the half and 9.6% MAT ex supermarkets. Now you've just got a total 4.9%. What do you have to say between supermarkets and ex supermarkets?

Yes. Sure, Sholto. We thought it's more prudent given the portfolio evolution to report a combined number moving forward. Since last half supermarket performance has grown by about $0.02, and the non-supermarket performance has come down. So the blended number is about 4.9%.

So what was supermarket growing at, I'm sorry?

Supermarket has grown by almost 2% above the last reported number. So in the 4s.

So 4. And what was the -- what's the other one got around it?

It's come down by about 2%.

Other down. Okay. And then what's trading been like ex supermarkets post in July?

Pretty good. Pretty good. June was an outstanding trading period for most retailers, but some of that trajectory has continued into July.

Okay. And then do you think this goes occupancy cost and productivity are then for your tenants?

I think we've always said, Sholto, the metrics we'd like to focus on is the cash collections, which are 99%, that were 99% all year last year and 99% for July. We focus on leasing spreads, which are at 6%. We have that data set, and we'll talk to you about it. But it's a pretty small data set for the whole portfolio. So it's not a meaningful number that we put out.

Okay. And then you talked about on the call, you want to get to 50% reweighting neighborhood. You've done -- you're only at 36% -- but you've done 3% reweighting in FY '23. What are you targeting at reweighting in '24 as a percentage of income?

We'll always be around that organically 1% to 2% through remixing, 1% to 2% through development and then opportunistically through asset recycling. I said last half that I was really comfortable with having a slightly higher proportion at this point in the cycle to large-format retail. And I think you can see from the organic growth we generated in FY '23 and the way the business absorbs property expense inflation that was -- that's proven to be the right call.

Okay. And then just on the final question on asset recycling. You sold Midland LFR in post balance date. Is there any plans to do any more? Is it more in the LFR space? Or what sort of assets would you look to sell, if any, in this financial year?

I think we've proven over the last 12 months, we recycled $285 million of assets, all at a premium combined to book. I think that's better than what all of our peers have done, proving that our book values are really robust and our assets remain in really high demand. We'll be opportunistic, and it will only be if we get a compelling offer on a property and we see a compelling opportunity elsewhere, whether that be in developments or acquisitions, but nothing more to say than that.

And then just on that, would you put more capital into the -- if there was something opportunistic in the Last Mile Fund? Would that be the best use of capital coupled with the developments? Is that -- or is it case by case?

Nothing under consideration for further investment in LML at all yet. We're really pleased with that investment. We made an equity investment of about $42 million, and we're sitting on a 20% gain on the said asset. So really pleased with that asset, which has been revalued based on income upside that the fund has generated. So we're pleased with what our position is today.

The next question comes from David Pobucky from Macquarie Group.

Congrats on the results, and thanks for the questions. Correct me if I'm wrong, it looks like the completion of Glenmore Park is delayed by about 6 months. Is that right? And if that's the case, what drove it, please?

No. Glenmore Park was always a 2-stage completion. Stage 1 is on track for completion in the first half, and Stage 2 is on track for completion in the second half.

Thanks for the color. I appreciate that. And just generally in terms of the environment for developments at the moment, what are you seeing in terms of cost inflation, labor and from a planning perspective as well, please?

Sure. I think we discussed last half that material costs inflation was actually pulling back, and we've seen some deflation in materials and products. However, wage inflation remained elevated last half. We're seeing green shoots now that some of that wage inflation pressure is coming off. But it's probably still too early to call that construction pricing will be moving down, but we're seeing some really green shoots out there in our conversations with our builders and their subcontractors.

And just one last one for me, please. Looking at a few of the other results, some of the other groups that have mentioned NPI margins have been impacted by increasing energy and land tax costs. Have you seen that yourselves? And what's been the impact of increasing costs on your NPI margins, please?

So that cost increase was largely borne in FY '23, and we addressed it in FY '23. The FY '23 to '24 bridge is showing a like-for-like expense increase of about 3%. So we proactively managed the controllable expense to offset any statutory increases, so our cost line increase is far more moderate than our peers because we went and address the problem last year.

The next question comes from Adam West from JPMorgan.

I just have a quick question here. Just with relation to the foot traffic data, have you seen any softening in the June quarter? And have you got any commentary around July?

So it's still showing pretty strong numbers at 30 June, as you can see. From pre-COVID to post-COVID, we're 20% up and year-on-year, we're north of 9% up. The story there is our assets are in the suburbs of Sydney, Melbourne and Brisbane, and the work-from-home trend has not dissipated, right, it's elevated. I think it will be here to stay for a while yet. And our assets being close to where people live in Sydney, Melbourne and Brisbane mean that we've got elevated foot traffic levels. And you might have seen 1 or 2 months up or down, but generally, that trend has held now for the better part of 2 years. July is no different.

Just on your lease. I'm just wondering, given you've sort of achieved 90% of the portfolio and the forecasting 7%, is that just a protracted inflated construction costs? Or do you still see that staying at 7% mark moving forward?

Yes. We've revised to 7% probably 1.5 years ago, when those construction cost inflation pressures were coming in, and we've held at that 7% number now consistently for 1.5 years. We'll always aim to do better than that, but we're comfortable with that target.

And then just on Mackay and Gregory Hills, do you see anything that could hold up the timing that would pushed it out past FY '24? Or that's all still on track?

Sorry, David, I just didn't hear that question.

So from Mackay and Gregory Hills, your development there. I was just wondering if you see anything that could follow up the timing and push it out past FY '24.

No, no, it will be delivered.

And then just last one for me. The remixing of the portfolio away from large format retail seems to be the focus for the group, can you just discuss the rental spreads you've typically been able achieve through this remixing? And if there's been any uplift from the shift away from large format?

So across the group in FY '23, we reported 6% blended leasing spreads on new leases, which is when we recycle into a new tenant from another tenant, the spreads were actually higher. They were double digits.

[Operator Instructions] The next question comes from Edward Day from Moelis Australia.

Just one for me. Just on your debt book, just wondering if you can talk through the elements of that, the restructuring of your hedges?

Yes, sure. So I mean, we're in a position to do that off the back of quite material hedging that we undertook in the first half of the calendar year. I mean it's sort of been called out as it is. I mean it's a noncash restructure. We've basically taken value from '26, '27 and basically been able to really put a line under interest for the next 2 years. And it's obviously some time that we have until '25 and we'll continue to pick our windows.

Yes. And have you seen any change in your margin as a result of it?

No. I mean, we actually refinanced some of the term debt in the second half and kind of 10 bp reduction in our margins on that.

The next question comes from Alex Prineas from Morningstar.

You've highlighted population growth or the high population growth in the catchments that you're in. Just wondering with national population growth having been very rapid since the end of lockdowns. Is that sort of normalized or even went back maybe below pre-COVID levels for a period of time. Can you just comment on how that would affect your -- the assets and particularly your thoughts around how that would affect the feasibility of developments? Is there much data there between the sort of near-term population growth and the ability to bring developments to market?

Yes, it's a great catalyst for our development pipeline. Our assets are located, yes, as I said, in the best suburbs of Sydney, Melbourne and Brisbane. So as population increases happen where the people live, they live in and around our assets, and they settle and they stablish their lives in and around our assets. That's the catalyst that gives us tenant population growth. It's not like some regional tenants which had a spike through COVID that have come back. Our assets are in the suburbs, the best metropolitan cities in Australia, and that's what underpins our development pipeline growth. So we're really excited about it.

And so if the population growth did slow, that would translate to sort of return metrics that you'd be estimating. Is that fair to say?

I think what we can see for the next 3 to 5 years is enough population growth for us to unlock our development pipeline and put embedded earnings growth for medium and long term through these assets. So we're very comfortable with where we're at.

At this time, we're showing no further questions. That does conclude our conference for today. Thank you for participating. You may now disconnect.