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

Thank you for standing by, and welcome to the HomeCo Daily Needs REIT FY '24 Half Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Sid Sharma, HMC Capital Head of Real Estate and HDN CEO. Please go ahead.

Good morning, everyone, and thank you for attending today's conference call. Joining me on the call today is HMC Group CFO, Will McMicking and HDN Fund Manager, Paul Doherty. 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 we extend that respect to all aboriginal and Torres Strait Islander peoples today. Let us begin on Slide 4. This has been another half of continued operational excellence and discipline for HDN. This has been coupled with proactive asset recycling to rebalance the portfolio. The HomeCo Daily Needs REIT focuses on assets that provide convenient essentials for local communities along with last-mile solutions for our retailers. I'm pleased to say our operational focus has continued with NOI improving to 4% plus, we are on track for completion of $70 million of projects that are delivering a 7% yield on cost. The top line income growth in this portfolio remains very compelling. The drivers for performance are simple. Firstly, our foot traffic growth is up 5%. Our retailers margins have improved, which drives tenant demand that ensures our leasing spreads are up 6.4%. Secondly, our cash collection is 99% every month we bill it, and our occupancy remains over 99%. And thirdly, like I just mentioned, our developments are on track, on budget and delivering an excellent yield on costs. We have an experienced management team that has been running HDN since IPO, and we continue to extract embedded value from our assets, which we will demonstrate today. Our assets are located in the best growth suburbs of Sydney, Melbourne, Brisbane. And these assets remain in high demand from tenants and investors. Convenience retail continued to outperform globally when compared to our retail peers. Over this half, we settled or contracted $300 million of LFR centers, broadly in line with our book values. There is no shortage of price discovery for the market assessing where NTA valuations should set for convenience retail. The blended passing yield on these assets was 5.4%. Partial proceeds from these divestments was used to acquire 2 brand-new Woolworths anchored daily needs assets into a Western Sydney's highest population growth suburbs, Kellyville and Leppington. These were secured off market from the Woolworths Group with good holding income of 5.4% and development upside. These transactions helped accelerate the re-weighting of our model portfolio, improving the overall income quality and growth of the business. The balance sheet remains in a strong position. Gearing of 34.3% is at the lower end of our range, and interest rate risk has been mitigated with over 92% of drawn debt hedged until FY '25. All in all, we continue to deliver what we say we're going to do. On Slide 5, many of you would be familiar with HDN's investment strategy, which remains unchanged. We continue to target a model portfolio of 50% neighborhood, 30% LFR and 20% health and services tenants. This mix balances the best characteristics, defensive, reliable income streams with sustainable growth. We have low rents set at the bottom of the landlord cost curve, sector-leading re-leasing spreads and a very high exposure to national retailers. We own 2.5 million square meters of land located in the best growth suburbs of this country. This underpins a $600 million development pipeline. We serve over 13 million Australians who live within a 10-kilometer radius of one of our centers. We're seeing over 90 million visitations per annum. As a result, our assets play a critical role in serving our tenant's omnichannel strategies. In summary, we continue to deliver on all strategic and operating metrics this half. I'll now hand over to Paul to take us through the results in detail.

Thanks, Sid. Turning now to Slide 7. HDN owns $4.7 billion of high-quality real estate, occupied by more than 1,200 tenants. 90% of our income escalates annually by 3.8%. 70% of this pie is fixed increases and 20% via CPI. Only 2% of FY '24 income remains to be committed in the second half. We've already commenced work on the FY '24 and '25 expiry profile, and this has reduced to 13%. HDN sustainable rents of just $380 per square meter combined with the high level of convenience and predominantly metropolitan locations provide a reliable platform for growth for our tenants and for unit holders. Moving now to Slide 8. HDN again maintained occupancy and cash collections of greater than 99%. This is a metric we are very pleased to have consistently reported on since IPO, November 20. It continues to underscore the portfolio's weighting towards high quality assets and robust tenant covenants. We were less correlated to the broader economic cycle. Net income growth increased to 4% in the period. This was driven by improved leasing spreads of 6.4% across 59,000 square meters. We're also very pleased to have consistently reported growing leasing spreads each period since IPO. Importantly, our leasing activity continues to maintain low incentives of just 5.2%, a slight reduction in June. Footfall remains elevated post-COVID as customers are increasingly living, working, shopping and dining closer to where they live. This is amplified by the fact that HDN centers are all located in the fastest-growing suburbs of Australia. As Sid noted earlier, visitation across our real estate is 90 million customers per annum. This is well -- this growth is well in excess of 20% over pre-COVID levels. As a result, HDN's retailers continued to perform strongly. Total MAT growth remained positive over the past 12 months, and is up about 20% over pre-COVID levels. We continue to proactively remix the tenant base. Our focus is to increase exposure to more defensive daily needs focused retailers and maintaining high exposure to national operator. HDN's portfolio includes high-quality retailers. 33% of gross income is derived from our top 10 tenants. And 7 of those out of 10 are ASX listed. Moving to Slide 9. On this slide, we'll provide some further detail about our top tenants and current portfolio weightings. As I said, we are rebalancing in line with the target portfolio weightings over time. I would now like to discuss our progress on sustainability, which we have set out on Slide 10. Our HMC group-level sustainability commitments are designed around our objective to create healthy communities. I'm pleased to report all the following initiatives delivered over the half which demonstrate the progress we are driving across the entire platform. On environmental, we are on track to deliver our Net Zero Energy Roadmap targets with a 30% reduction in Scope 1 and Scope 2 carbon emissions to be achieved by FY '24. This will be reached primarily through our key environmental initiatives, smart energy management program and ongoing investment in solar power infrastructure. We're on track for EMS to be installed for all remaining feasible sites in FY '24. In terms of solar rollout, we now have solar active in 12 sites and a further 15 sites are in design and in construction. We're proud of our continued progress with both initiatives across our HDN portfolio. On social, we have achieved our 50% gender diversity target across the whole organization as well as across independent Board Director positions in the group. We are continuing to progress on social initiatives. Our Reflect Action Plan has now been endorsed by Reconciliation Australia. RAP initiatives are underway across the group and our national partnership with Eat Up is progressing with initial planning underway across a number of HDN assets. And on governance, HDN was awarded ESG Regional Top-Rated company for a second year in a row. HDN has also lodged its second Modern Slavery Statement, and we continue to adhere to responsible investment standards for all of our acquisitions. The team is proud of the tangible progress we are making in our sustainability strategy. Moving now to Slide 11. This slide shows our Net Zero Energy Roadmap on Scope 1 and Scope 2 emissions by FY '28. We can see progress against our targets over the last 2 years as well as our initiatives to get us there in FY '28. As discussed in the previous slide, we're well underway to achieve our FY '24 targets, in addition to planning for our upcoming targets. I would now like to take you through HDN's growth opportunities, which commence on Slide 13. HDN executed on over $300 million in asset sales throughout the period. These were broadly in line with book values. This underscores the quality of our portfolio and highlights the level of demand for our assets. As Sid said earlier, proceeds from disposals have been partially recycled into the off-market acquisition of 2 brand-new Woolworths anchored daily needs assets. These are high-quality acquisitions, and they help to improve the overall composition of the portfolio, provide greater income security over the long term and accelerate the re-weighting of HDN's model portfolio. Turning now to Slide 14, which highlights our development pipeline. We're pleased to have upscaled the pipeline last year to $600 million. It underscores in more detail the substantial embedded growth opportunity in the portfolio. We firmly believe this is a major differentiator for HDN. We're regularly asked if this includes longer-dated mixed use of residential opportunities. The simple answer is it doesn't. This is simply the pipeline [ anchored daily needs ] retail projects we have in front of us today. We will deliver these over the medium term. Development pipeline is a key strategic pillar for the group. It offers compelling risk-adjusted returns. It is accelerating HDN's tenant remixing towards more defensive daily needs tenants and it is tenant demand led. Turning now to Slide 15. This slide provides some further information on the $70 million of projects currently underway in the portfolio. All of these projects are 100% committed. Turning now to Slide 16. On this slide, we wanted to highlight what we've always done when we make acquisitions. That is to optimize the leasing mix to improve the income, providing incremental value. Whilst this example is in relation to Southlands, which we acquired in FY '23, not something new. There are many examples where we have delivered these outcomes, including Gregory Hills, Marsden, Queensland and Armstrong Creek to name a few. And we expect to deliver similar outcomes in the recently acquired Kellyville and Leppington. Turning now to Slide 17. Slide 17 provides some more detail on the individual projects in the portfolio. We are committed to targeting $120 million or more of developments -- commencements annually. However, we will exercise strong commercial rationale in executing this and commencements will always be subject to achieving sustainable returns and maintaining balance sheet strength. I'd now like to hand over to Will to provide some commentary on the financial results.

Thanks, Paul. Turning now to Slide 19 to go through the earnings summary. Property net income grew to $136 million in the first half of FY '24, driven by the strong performance of key property indicators, which included weighted average rent reviews of 3.8%, re-leasing spreads of 6.4%, development completions and active expense management. Overall, HDN recorded first half FY '24 FFO of $88.5 million or $0.043 per unit. Turning now to Slide 20. HDN has a robust balance sheet at December with net assets of $3 billion and gearing at 34.3%. December '23 net tangible assets was $1.44 per unit reporting a modest 3% reduction versus June. This was primarily driven by a softening in the portfolio cap rate from 5.5% to 5.6%, which was partially offset by property income growth. The strength of the property portfolio has enabled continued asset recycling with the divestment of non-core properties broadly in line with book values, and the acquisition of 2 brand-new Woolworths anchored daily needs assets in high-growth Western Sydney locations. These are due to settle in the second half. Turning now to Slide 21 to talk to capital management. December '23 gearing of 34.3% continues to be at the lower end of the target gearing range. Hedged debt remains high at 92% and provides strong interest rate protection in FY '24 and FY '25. During the period, HDN also refinanced its near-term debt expiries, which resulted in an improvement in its credit margin. Summary of the debt and hedging book is also detailed on this slide. I'll now hand it back to Sid to provide closing remarks.

Thanks, Will. Turning now to Page 23. We're really proud of the team and the results we've achieved this half. We're one of the few retail REITs to have had year-on-year top line revenue growth, offsetting the interest rate fluctuation over the prevailing period. Our focus remains, firstly, on operational excellence; secondly, on developments and selective asset recycling; and thirdly, having a robust balance sheet with appropriate gearing and hedging. We reaffirm our FFO guidance of $0.086 per unit and distributions of $0.083. Our management team and Board remain disciplined and focused as we've always done. I'll now hand over to the operator for questions.

[Operator Instructions] Your first question comes from Lou Pirenc with Jarden.

Yes. Just one question on asset recycling kind of you've clearly made good progress in the last 6 months as you've done before. So what -- if you kind of look at your current portfolio, kind of what percentage do you kind of see as opportunities to recycle capital? And how do you see markets for acquiring assets going forward?

The market for the type of assets we have with the operating fundamentals and the land fundamentals that we have continue to remain in really high demand. We're always opportunistic with the asset recycling program. So if we see an opportunity that makes sense, we know that we've got the flexibility in our current assets to recycle out of LFR into anchored daily needs to rebalance our portfolio.

Great. And then on Page 13, clearly, you're selling and buying assets at similar yields. So I imagine it's just a question of different growth outlooks beyond that initial yield that kind of drives that recycling?

That's right. That's exactly right. So we sold assets on equivalent yields to what we bought them on initially, but the growth outlook on what we bought, especially from a development perspective, is outstanding. So what we bought in Leppington is 3 train stations away from the new Badgerys Creek Airport. It comes with a lot of excess land. It's a major town center with a brand-new train station that opened 2 years ago. So the growth fundamentals of what we bought in Western Sydney, the fastest-growing corridor in the country is really compelling, and we look forward in the next half to giving you some more color around the development potential of these acquisitions, a bit like we did with Southlands this half.

Your next question comes from Cody Shield with UBS.

Just a question on the acquisitions. Where are sales for those assets expected this year? And where is that going to be relative to the turnover threshold?

We don't disclose the turnover thresholds of these assets. They're brand-new assets. So they're in ramp-up mode. Importantly, the rent per meter paid by the anchors and the specialties, which is what we always focus on is sustainable and will grow over time. So we put some color out there. These assets should deliver as IRRs north of 10.

Okay. Great. And are you able to provide any color around the recovery of outgoings with tenants on those deals?

So what we said in the past and the same thing holds, outgoings recovery rate for LFR centers are higher, 50% to 70%; outgoings recovery rates on neighborhood centers are 30% to 50%.

Your next question comes from Sholto Maconochie with Jefferies.

Just on the asset acquisition and capital recycle, I think you've got your target weightings, 50% neighborhood and 30% LFR. Your LFR is 47%. It's fair to say you just dilute that exposure via the development pipeline and net acquisitions as opposed to selling the LFR and some LFR assets? Or how do you look at that getting to a model portfolio?

Yes, Sholto. The way I'd look at it is, every year, we want to aim for 1% to 2% through tenant remixing in the portfolio, 1% to 2% through developments and 1% to 2% through asset recycling. So that's how we frame it now. I think we've made some good progress in that, and we'll continue to make that progress in a considered and disciplined manner.

Good. And then I mean, pretty high hedging 92%. So the BBSW doesn't make that much difference. But I think you're guiding to 4.5%. FY '23 is sort of running 4.3%. Do you still assume 4.5% in the guidance currently?

Yes, that's right, Sholto. Yes, the key point is high hedging now and into FY '25.

Yes. Good. And then just on the development pipeline that's still on track, is that mainly focused on, again, the convenience sort of style thing and remixing some of LFR? What's the sort of how do we think about the sort of style of development?

So daily needs, health and wellness and leisure and lifestyle in terms of priorities.

Your next question comes from Andy MacFarlane with Bell Potter.

Just a couple of quick ones for me. Just on development, it looks like there's a couple of numbers in the press release in terms of completions, we see $80 million and $70 million in there. Just wondering what the difference is? And has that number come down? Or what's the correct number for FY '24 completions?

We're targeting commencements of $80 million moving forward. So there's new...

$120 million...

$120 million is moving forward annually. $70 million is the target completions for the end of the year, projects that are currently in progress.

So it's $70 million of CapEx out of the door, Andy. That's what's on track financial year and the $80 million will be as the complete number. So that's probably 1 or 2 numbers there.

Yes. That makes sense. Just in terms of yields on costs, obviously, you're still quoting kind of 7% and growth numbers there, but just interested in what you're seeing in terms of better rents and stable costs and I guess, where you think the trajectory is headed?

Yes, the rental outlook continues to improve. Our leasing spreads are a testament to that. Tenant demand hasn't wavered. So the rental outlook is really positive. What's interesting now is material costs have come down significantly. So there's some green shoots in terms of construction pricing. There are some improvements also in the labor market, given the net migration that's come to the country over the last year. So we're seeing the outlook for construction improving moderately over the next 6 to 12 months.

Excellent. And one last one. Just in terms of -- on the rent side of things. You've seen gross rents have crept up $357 to $380 in the period. Just wondering where you think the portfolio sits at the moment in terms of overall under-renting overall?

Compared to all of our peers in the sector, the short answer is we're under rented. Because, firstly, the composition of our tenant base today; secondly, the age of our assets. So we think there's a lot of upside ahead on the rental rates, but we'll do it in a disciplined manner to make sure that when we are getting these gross rental -- gross rents from our tenants, we're doing so in a sustainable manner where all of our retailers are improving their profits and margins and want to continue to work with us.

Give a sense on the percentage of that under rented then?

Yes. I'm not going to pin ourselves to a number. But I think you can do the analytics with our comps, and we're well under if you compare us to our peers.

Your next question comes from David Pobucky with Macquarie Group.

Just the first one on sales growth slowing. If you could please just provide a bit more color on the drivers there. It looks like that was flat, but foot traffic was up 5% year-on-year. So I just wanted to ask about the allocation of spend.

Yes, sure. Look, we're owners of real estate. As we've always said, the key metrics are rent collection, occupancy, leasing spreads, rental rates. Everybody asks for sales data. Now only 30% to 40% of our retailers provide it. So we provide the color. What you're seeing in that sales moderation in terms of growth is simply deflation coming through by some of our tenants. They're still holding margins. And if you have a look at all the listed retailers that have released their results, margins have either remained flat or improved over the last little period. So not much of a read-through on the sales. The thing to look for and what we look for is our job is to bring [ wallets pass windows ]. We're doing that job. We're doing it well, and we're growing our rents.

And maybe just a follow-up on leasing spreads, up 6.4% and they've been trending up since IPO, as you mentioned. I know you touched on this already a little bit, but sales are declining. So I just wanted to ask how you think about spreads going forward, please?

The way to think about it is every time we proactively remix our portfolio, our leasing spreads are double digit. So I think there's a lot of good momentum ahead of us to continue those leasing spreads into the next period.

And just last one. You've refinanced near-term debt expiries. And you mentioned which resulted in an improvement in credit margins. Just wanted to ask what that improvement was, please?

Yes. We -- so we refinanced 2 tranches, the average term was 3 years, and it was 1.3%, so a 10 basis points improvement. We've recently got an investment-grade credit rating and that's flowing through to good credit margins.

Your next question comes from Richard Jones with JPMorgan.

Sorry, I just got a follow on. Just in terms of the sales data. I appreciate you're only getting 30%, 40% of your retailers reporting sales. Can you kind of clarify what is the mix within that bucket? And can you provide any color perhaps on how supermarkets versus specialties versus traditional large format retailers are going from the sales data that you get?

It's a pretty even spread, Richard. As I said, I think the thing to focus on is deflation. That's all it is, good deflation, supply chain deflation, our volumes are up, our foot traffic is up. So it's purely a bit of deflation coming through the sector.

Okay. So I imagine the supermarkets obviously have to report sales, but you don't get much sales growth -- sales data beyond that. Is that right? Or...

Yes. No, we -- it's an even split made about 50-50 in terms of your reports. So we get enough supermarkets, we got enough of LFR, especially [ reporting ]. But it's only a small portion of the portfolio. And I think the point to call out is retailers' margins are improving. That's what's driving rental growth.

Okay. And can we maybe touch on the re-leasing within the portfolio. Obviously, you've reformatted a bunch of the old Masters stores that kind of initiated this vehicle. Most of those leases are still, I would assume, not being -- will not come up. And so I imagine the bulk of the re-leasing you've done is in the old Aventus portfolio. Can you just clarify, if that's right?

Yes, that's right. Most of the Masters portfolio had between 8- to 10-year leases. Not a lot of them have been recycled, some of them proactively just in terms of optimizing mix, but the upside is predominantly coming through a lot of the Aventus centers that we bought. When we did that merger coming on almost 2.5 years ago, a lot of people asked us why we did it. Well, this is the reason why because we're getting great rental growth out of those assets, and we knew that was embedded upside to unlock with discipline and focus.

Okay. I was just interested in how you think the rents sit within the old Masters boxes and whether you think the re-leasing spreads that you're getting from the Aventus portfolio is about what you're getting in Masters as it sits today? Or do you think there's upside to that?

It's a good question, Richard. As you may recall before the merger 2.5 years ago, the Aventus per square meter rents were higher than the Masters. That would imply that there's more upside in the Masters' leases when they start coming up in '26, '27, '28. However, I'm not going to guide to a number on that. We'll just do it in a disciplined manner and hopefully, just keep delivering great results every half for you.

[Operator Instructions] Your next question comes from Alex Prineas with Morningstar.

Just sort of observing some of the general retail REIT results out there. It's been a pretty consistent message that the smaller retail and convenience retail, those assets are the more liquid part of the market. And there's been a lot of commentary around maybe institutional buyers are less active at the larger end of the market, but smaller buyers and sellers are more active at that smaller end of the market. You're actually sort of trading in and out of assets that are similarly sized at that kind of smaller end of the market, I guess. So I'm just wondering sort of have you got a view on why you're able to get that better growth profile on those assets that you're purchasing. Are you coming up against the same sort of buyers and sellers in the assets that you're getting out of versus the ones that you're getting into? Or are they still really different markets for whatever reason of those assets that you're getting into that enables you to potentially get the same cap rate on what you're buying into there, but with a better growth profile? Do you have a view on that?

Yes. No, I think I understand the question. The subregional into town and the large regional into town, both of which HomeCo doesn't play in, frankly, affected by fundamental rental growth issues. They have a tenancy mix and composition that is not fit for purpose in an omnichannel environment over the next decade. Convenience retail, whether it's neighborhoods and large-format retail remain in high demand from private and institutions and increasingly global institutions. We've always said convenience retail, whether it's LFR or neighborhoods will converge in yield and will converge in quality over time, and you can see evidence of that. We recycled out of large-format retail assets at the same yield that we have recycled into high-quality brand-new assets in Western Sydney from the Woolworths Group that we secured off market. So that's our investment thesis historically, and I think you're seeing evidence of that. The last thing I'd say to it is the reason for our success is we are predominantly metropolitan focused. Sydney, Melbourne, Brisbane, Perth, the fastest-growing suburbs in the country are where our assets are. We don't have a lot of country town exposure, which are far more volatile with a lot less tenant demand. Our fundamentals are just better because where they're located. So I wouldn't compare us in terms of asset quality to any other portfolio that's out there on the board, right? This is a metropolitan portfolio, you couldn't replicate it. That's why we've been successful.

Okay. And so the -- say, the assets that you sold out of the buyers of those -- were you seeing those buyers also maybe competing for some of the assets that you were looking to buy, I guess I'm just wondering -- sorry?

As I said private, net worth privates -- high net worth privates, domestic and global institution funds are looking for convenience retail, whether it's LFR or neighborhood, most of them that are looking for sustained growth are looking for convenience and the fundamental drivers on both LFR and neighborhood is still strong. It's the same group of buyers and sellers, but they can't get set. That's why we've got success.

There are no further questions at this time. I'll now hand back to Mr. Sharma for closing remarks.

Thank you, Alex. Thanks, everyone, for your continued interest in the HomeCo Daily Needs REIT. We'd like to thank our management team and our Board for their continued support. This is a disciplined group. It's been disciplined for a number of years now. It's got a great group of assets, and all we do each day is work them very hard to extract value for our investors. Thank you, and look forward to catching up with all of you soon.

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