Ingenia Communities Group (INA) Earnings Call Transcript & Summary

2:20 session at Citi's 2020 Global Property CEO Conference. I'm Adrian Dark here with David Lloyd from Citi Research. We're pleased to have Stockland and Ingenia join us today. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast, on the Disclosures tab. For those in the room or the webcast, you can sign on to liveqa.com and enter code citi2020 to submit any questions or you can just raise your hand. Mark and Simon, we'll turn over to you to introduce your company and management team and provide the audience three reasons why investors should buy your stock today, and then we'll turn it over to Q&A. Mark, perhaps we'll start with you.

Okay. Thanks, Adrian. So Tiernan O'Rourke, our CFO, has just walked in the room; and Mel Buffier, our Head of Investor Relations. So Stockland is largest listed diversified real estate company in Australia, $15.1 billion of assets. Split roughly, 70% commercial property, 30% communities. Our strategy is, ultimately, to provide returns above the sector average, with a focus on leveraging the residential cycle. So we've got a 76,000-lot inventory. And so as the largest residential developer in Australia, we're well positioned, and we've seen an increase in national inquiry of about 159% in the last 6 months. So we're seeing a pretty strong recovery. We offer, at the moment, a 6.9% -- or sorry, 5.9% distribution yield and an 8% EPS yield. And we've got a $4.3 billion commercial development pipeline, yielding 6% FFO yield, which will provide further long-term growth.

Thank you. Simon?

Hi. I'm Simon Owen, the Chief Executive and Managing Director of Ingenia Communities. And with me is Donna Byrne, who heads up our Investor Relations. We're the largest owner, operator and developer of manufactured housing and RV communities in Australia. In the last 12 months to 31 December, we were the highest performing REIT in Australia, returning our investors over 76% return. Our focus is on building our manufactured housing business in Australia. We have the sector's largest pipeline of over 4,200 home sites. And since entering the sector back in 2013, we have considerable first-mover advantage through the -- I guess, the ecosystem that we've established with suppliers, with the owners of parks, and now we've assembled a great team.

Thank you. A question that we're asking to open each session. ESG is of increasing importance for all company stakeholders. What's one thing your company is doing to improve your overall ESG score over the next 12 months? Maybe, Simon, you can go ahead.

Yes. I think the first thing we do is committing to public reporting on our ESG framework, which we'll be releasing over the next 12 months, and that will be introduced using a GRR -- GRI framework. And then secondly, in specific actions, we're going through a process of investing several millions of dollars of putting solar panels on every one of our 2,500 RV units. So we're making significant contribution at the moment.

Thank you. Mark?

Yes. So Stockland's a sector leader in GRESB and DJSI. So we've been a sector leader for 10 years. I guess the key thing we're doing at the moment, we've got a $33 million rooftop solar program that's rolling out of about 16 megawatts of production within 12 months. We're also, as part of our targets to move to net 0 by 2030 in retirement living, logistics and head offices, we'll be looking to do an Australian first, which will be trading green power in front of the meter, which will incorporate a multimillion-dollar rollout of solar onto our logistics rooftops to augment what we've already done with retail town centers.

Thank you. We might start just, I suppose, for the benefit of the audience, if you can perhaps just talk about the exposure that each of your businesses has slightly more specifically to the residential market in Australia, your product types that you're active in, which geographic markets and perhaps give us a context on scale as well, please? Mark?

Yes. So the residential communities business, we've got 42 active projects. As I mentioned, 76,000 lot inventory. Average age of inventory is about 9 years, so there's a lot of embedded margin in that. We sold a super lot last year, The Grove, at a 50% premium to book value, just illustrating, I guess, the embedded value. This year, we said our operating profit margin will be 19%. We've guided to '21, that'll be around 18%, indicating that volumes for '20 will be over 5,200 lots, and that it'll be around 5,800 lots in 2021. We've got 42 active projects. And I guess on the over-55s, we've got a traditional deferred management fee business, and we're moving into or following Simon's footsteps with a 2,000 dwelling existing inventory for manufactured homes, which is on 10 sites within our masterplanned communities, and we can move those up to about 4,000 by extending the individual lots. And each new masterplanned community that we do from here will probably have a manufactured home or land lease component. And I guess, just to step back, our masterplanned communities are anything from 2,000 families typically to 50,000, and we're bringing all the enabling infrastructure: the town centers, schools, parks, playgrounds, all that type of thing.

Yes. From Ingenia's perspective, we have, firstly, the largest MHE pipeline in Australia of around 4,200 home sites. We've had 6 consecutive years of growing the number of settlements that we're achieving. So even back in the financial year ended 30 June 2019, which, apart from May and June was a pretty challenging year, we had a record year in terms of selling a record number of settlements at the highest price we've ever achieved. Our margins have continued to expand, and we're also charging more for our ground lease rents. Our key exposure to the residential market in Australia is really a flow-through from every single one of our residents moving into an MHE in Australia has to sell their stick-built home because there is no finance available for MH in Australia. So our key exposure comes down to, I guess, the underlying strength of the residential market. But from our experience over the last 7 or 8 years, typically, our residents are selling their home to a first home buyer or upgrader. At the moment in Australia, like the U.S., you've got very low unemployment. Interest rates are extremely low. The banks are starting to open up the finance, so we're still seeing that there is a buoyant market for the homes that our residents are selling to fund moving into one of our communities. Probably the greatest headwind that we face at the moment is just the time on market that it takes our residents to sell their family home to move in. We're not really seeing a lot of movement there. So going back 2 or 3 years, time on market was typically around 30 days. At the moment, the average across our portfolio is around 62 days, and that just slows down the overall cycle time. In terms of the size of the market, our analysis suggests that 2.1% of the population in Australia over the age of 65 lives in manufactured housing. The sector is currently delivering somewhere between 1,500 to 2,000 new manufactured homes, of which Ingenia is delivering around 400 of those. To increase that penetration rate to 3% of the population over the age of 65, the sector needs to be building over 7,000 new manufactured homes a year. But the entire supply of sites that Ingenia has and Stockland has and the other key players is only 16,000 sites. So we're in, I guess, a position where our industry at the moment is significantly supply constrained. We know that from the new communities we're launching that an absorption rate of between 8 and 10 homes a month is absolutely achievable, so we're really focusing on freeing up more land supply to make sure we can continue to accelerate development.

Thank you. I think you both touched on the cycle, but we obviously went through a downturn in the residential market in Australia from sort of 2017 through to 2019 and had a fairly large decline in house prices, at least by Australian standards, just over 10%. But it does seem that conditions have been getting better since the middle of last year. Could you maybe talk about the catalyst for that shift as you see it? And what your expectations are for prices and volumes going forward?

Maybe you're on first.

Okay. So the election was the big turning point. I think there was a lot of concern about the opposition getting in, and they had very negative housing policies. So I guess, the restatement of the coalition was very important. The ending of the Royal Commission into the banks was significant and the progressive easing of credit, particularly for owner-occupiers. It's fair to say, if you look at bank lending growth at the moment, it's running at 4%. At the bottom of the cycle, it got down to 2%, 2.5%. Obviously, a long way from normal, but the prior peak of cycle loan growth was running at 22%, just to put it in context. So bank lending in Australia at the moment has improved. We would say it's not normal at the moment. It still takes more than a month typically to get an approval. And independent valuations are required for each time an applicant does make an application. But it's now clear with the brokers and the borrowers what documentation is required for the banks and therefore, credit is flowing, and that's what's translated into those very significant uplifts in demand that I mentioned earlier. We had a release on the weekend in Sydney. We had campouts again. We sold out in 2 hours. That's not a good outcome. We like customers, obviously, not to have to be in that situation. But it's very clear that there is an undersupply in the market, and that will become more acute because ultimately, smaller developers are not getting funding at the moment from the banks. Chinese developers are not participating either. Apartment commencements are off, depending on which market you're looking at, between 20% and 40%, and they typically have a 2-year cycle -- build cycle and at least 1 year to 2 years in planning. So you will mathematically have a continuation of this underbuild. And of course, the population is continuing to grow at 1.5% per annum. So we think that you'll see a pretty strong 4- to 6-year upcycle, and we're about 6 months into that at the moment.

Simon?

Yes. I would echo Mark's comments and a couple of other callouts is on the supply side, the volumes going through are still pretty limited, which is certainly putting pressure that -- for people who want to buy housing. There's not a lot of stock out there of mature homes. Yes, I think for seniors, which is really the market we focus on, there hasn't been a lot of new product coming out in new markets. So we had an open day up in Harvey Bay, which is about 4 hours north of Brisbane. It's a -- quite a large regional seaside town. And we had over 650 people attend our open day, and we took a record number of deposits on the day. In my 17 years in the seniors housing industry, I've never seen anything like it. But you know seniors can be very, I guess, fickle, so I would have no doubt that the coronavirus is going to inevitably lead to seniors staying in the family home rather than coming out and inspecting our community. So that sort of sentiment is really strong. But we still haven't seen a lot of tightening in the days on market. So I think from Ingenia's perspective, trading conditions are good, but they're certainly not where they were 2.5, 3 years ago.

Simon, just -- you just touched on the increased penetration, if you're able to achieve that, what that means. Are there any other structural factors that are driving the demand for your type of accommodation? I suppose it's relevant for Mark as well as they build out their MHE business?

Yes. I mean when we first started pivoting out of the deferred management fee model, which is my long-term experience into manufactured housing, the key thesis there was that in Australia, around 78% of seniors, people over the age of 65, own their home outright with no mortgage or incumbents, but the vast majority of them have less than $100,000 in savings. So outside the equity they have in their home, the vast majority of them don't have access to a lot of money. So we felt that manufactured housing provided a great opportunity for people to sell their traditional or stick-built home, invest 60% to 70% moving into one of our manufactured housing communities and then free up equity to fund a more comfortable retirement or help their kids. And the conversations we had 4, 5 years ago when we really started developing was, we really had to educate the market, our residents and their families, on what land-leased communities were and how it worked that you didn't actually own the land. Today, what we're finding in the open days that we're running and the conversations we're having with prospective residents is they all know what MH is, they know how the model works. It's just, when can I buy in? So in our larger masterplanned communities, our biggest challenge is keeping up with the demand. So in our Latitude One community, up just north of Newcastle, we have typically between 2 and 3 different building companies on-site at any point in time, a couple of hundred builders just trying to keep up with the demand. We're typically settling between 10 and 12 homes a month. It's the same at our Plantations community up near Coffs Harbour. So I think it's -- 3 or 4 years ago, the conversation is very much about information. Now it's the consumer absolutely understands what MH is and that it's really a different proposition to the traditional DMF model in Australia, which I think DMF still has a great place because we can't build manufactured housing communities in inner or middle-ring Sydney, Brisbane and Melbourne, because we just can't get the land.

I suppose -- I mean your target market is pretty well defined. But Mark, you guys are playing to a broader suite of potential buyers, first-time buyers, upgraders, et cetera. Can you maybe just elaborate maybe on what you're seeing in those distinct sort of cohorts? And maybe how your product type is likely to evolve over the next sort of 3 to 5 years?

Yes. No worries, David. So I mean the first-time buyers were the first group to really engage with the market as it improved last year, which is really reflecting credit availability. And first-time buyers are about half of our buyer group at the moment and have been fairly consistently around that level. Owner-occupiers, overall, at the moment are sitting at about 80% of buyers, so the other 30% to 80% is people who are downsizing and also upgraders. So part of what we have been doing is more townhome product to accommodate, in particular, the downsizer market and also to meet a lower price point around affordability. And then investors who really dropped away. I mean they got down to about 15% of our buyers last -- early last year. They're now moving up from 20% back towards the long-term average of 25%. It's -- they've been most active in Southeast Queensland. So they've moved to about 1/3 of our buyers there. But that's because of the yield. So typically, yields -- rental yields are about 4.5%, close to 5% gross in Southeast Queensland. To what sort of product are we doing? So I mentioned townhomes. Where we can work with regulators, we're also trying to focus on further densification. So in Southeast Queensland for argument's sake, we can currently do micro lot product on 72 square meters with an entry price of about $230,000. That's proving for a 3-bedroom townhome with attached garage to be pretty compelling from a customer point of view. We also are looking at how we can potentially manufacture townhomes because we have supply chain issues. At the moment, we can't find builders who can do more than about 40 townhomes at a time. And we would ultimately like to be doing a couple of thousand townhomes a year at least, so we need to find a more reliable supply chain. We're also moving, as I said earlier, into the manufactured home space. So we would hope that once again, that will probably run ideally at about 1,000 dwellings a year as we ramp up to scale. And given there's been a big pullback in the apartment market, and there's been issues with some of the quality of buildings. There's been high profile cases of cracking slabs and flammable facades. So Stockland's actually got the highest brand recognition in Australia at the moment of any property company. So we believe there's trust in our products, having operated consistently for 67 years. And so you will see us ramp up countercyclically into the apartment mixed-use space as well. Once again, ideally, we'd like to target 1,000-plus apartments a year if you're talking over that 5-year time frame that you described, David.

A question from liveqa. What are some of the key supply constraints you've identified in the MH sector? And do you expect these to remain intact for the next 2 to 3 years?

Yes. So when we started in MH back in 2013, every home we built came out of a factory. Unlike America, where you can go to Clayton Homes or Cavco or Champion, and there's genuine robotics in the factories and there's scale. In Australia, every single MH builder, with the exception of Fleetwood, is a family-owned company with one factory. And as we started flexing up supply, we did have some significant supply-constraint issues there. Commencing in 2016, we started actually doing slab-on-ground manufactured homes, which are still capable of being relocated, and it has been a process of finding builders who can understand and build to the methodology we use, which is basically pouring a concrete slab, having a steel chassis and then the home is attached to the steel chassis so it still can be relocated. Yes, there's an increasing number of builders, but the challenge is trying to -- when you're in a single community selling 10 or 12 homes a month, it is hard to ensure the quality. So probably the main supply constraint at the moment is we use half a dozen builders that we're very comfortable with. That each of them is now -- probably 50% of their business is Ingenia. That's some -- that's -- we wouldn't want to be any more than 50% of their business. So it's not an overall constraint but is something that we're very focused on. And then in terms of the -- specifically the coronavirus, we've spent a lot of time internally looking at our supply chains. And over the next 6 months, our key homebuilders tell us that there won't be any issues, but if this is an extended pandemic, then probably the key bottlenecks is going to be around the electrical goods that go into the homes. And secondly, the plumbing and fixtures. So all the glass we use is made in Australia, but if the coronavirus continues for more than 6 months then around those 2 areas. There could be some either delays or potentially cost impasse.

Thank you. You sort of touched on it, but the issue of affordability used to be a really topical one in the Aussie market. Obviously, it becomes less of an issue as prices have come down and interest rates have progressively come down as well. But interested in your take on the extent to which it's an issue in Australia today? And also how your businesses are positioned for that? Maybe Mark first?

Yes. Well, I guess, the -- we've always focused on affordability as a central premise, where densifying within our masterplanned communities, we can bring down the average price points to ensure that we are typically 10% to 20% below the median house price in the locations that we operate in. And so we've always got a high proportion of affordable products in our communities. I guess, nationally, what I'd highlight at the moment is with interest rates as low as they are, mortgage repayment obligations as a percentage of income are at the lowest levels, typically, particularly in Southeast Queensland and Perth, that they've been in 30 to 40 years. And in Sydney and Melbourne, they're back down below the long-term averages. So in that context, if you buy into lower for longer, then affordability is quite reasonable. And maybe just to put it in context, there's been a lot of infrastructure expenditure in Australia, over $100 billion on the Eastern seaboard alone. If you look in the last 6.5 years, we've been buying land and activating projects that are on new railway lines or existing. The new, in particular, has opened in the last -- or is opening as we speak, has opened typically in the last 12 months. In Melbourne, you can buy from us a 4-bedroom brand-new home with attached garage for $458,000, and that will be 30 minutes, 35 minutes from the Melbourne CBD. So from a point of view of accessibility in gateway cities, that's actually pretty affordable. And so the infrastructure changes are redefining accessibility in a number of the key cities as well.

Simon?

Yes. From our perspective, I mean, the whole thesis for moving into MH was we trying to deliver affordable housing to Australia's aging population. And we've always felt that cheap is deep. It's -- I guess, across the 10 communities that we have under development. Most of the communities in New South Wales, there's actually -- the highest level of demand is for the biggest homes: the 3 bedrooms with the study and a double carport, and when we open a community, we typically have 6 different model types that are available. And by far, the overwhelming preference is for the larger homes. Conversely, in Queensland, particularly in our 2 projects in Logan and certainly up in Harvey Bay, there's an overwhelming preference for a more affordable home, and we've been working very hard with our builders, and we've finally got the build cost per square meter to be under $1,000 a square meter now, which includes landscaping, which is the lowest we've ever achieved. Over the years, we have looked at importing homes out of China, and we have previously imported 71 bedroom homes, which are up in Brisbane. We actually rent those out as a build-to-rent model rather than sell them off. And for a while, we've been working very closely with our U.S. strategic partner, Sun Communities, on -- if you look at a company like Clayton Homes, they build something like 65,000 homes a year across 14 factories. It takes them 3 days to build a home. We did look at the logistics of bringing those homes from the U.S. out to Australia just to really lower the price point because our research suggests that homebuilding prices in Australia are around 3x what it costs in the U.S. But because of different codes, because of the depreciating Australian dollar and the cost of shipping, to date, that hasn't proved to be viable.

Simon, you just touched on your relationship with Sun. Maybe you could just firstly elaborate on that? And then secondly, you have been in the U.S. a number of times. What are the learnings you've taken from the U.S. and applied to the Australian market?

Yes. So back in October 2018, we entered into a strategic partnership with Sun. So we placed 10% of our stock with Sun at an 8% premium to an all-time high share price at that time. And Sun has the right for the next 5 years to participate in all-new greenfield development that we do. We have one community coming out of the ground at the moment just north of Brisbane in Burpengary. Our first resident moves in next month. And we have a second project just north of Newcastle. So Sun has been a great strategic partner. Before Sun came on the register, U.S. investors would have represented less than 10%. And now, U.S. investors are well over 40% of our register. Everyone knows Sun, and that's been a great opportunity for us to market over here. I guess the key learnings and the time I spent over here in the U.S. is really in a couple of areas. One of the most exciting areas for me in MH is finance. So in the U.S., Warren Buffett owned Century 21, and Vanderbilt provides chattel finance for MH over here. That model does not exist in Australia, and it's something we've been working on for the last 4 years. And we have looked at working with Sun, but they have given us their -- I guess, all of their knowledge because they do provide finance and then third party it on. I would hope that this year -- in this calendar year that we'll have a finance product that we can launch for manufactured housing. Yes, just touring their communities in the last few days, just looking at opportunities for incremental income streams. It's been really insightful. It's looked at the way we framed our strategy over the last 5 years. We've also pushed into RV, being recreational vehicle communities. So I guess all of that's refined our strategy over the last 4 or 5 years.

Can you maybe just touch on the economics of the business as you see it? And perhaps how that might be similar or different to the U.S.?

Well, in the U.S., the typical cost of a new manufactured home to the consumer is somewhere between $80,000 and $100,000. And so that is less than half of the average price for stick-built home in the U.S. In Australia, for the last -- over the last 6 months, the weighted average sales price that we were selling a new manufactured home for was $440 -- $440,000. And that is around 80% of the median house price in Australia. So that has been quite -- I guess, that part is quite different, but many other parts of the industry over here in terms of providing affordable housing. Our site rents are very similar. The penetration rate is -- so the sales rate is very similar. Probably the other key difference, apart from finance that I mentioned in the U.S., 20 million people or 6% of the population of the U.S. live in manufactured housing. In Australia, it's exclusively for seniors because there's no finance, and the penetration rate is 2.1% of people over the age of 65%. So if we were just to increase that penetration rate to 3%, we have to triple the amount of homes -- new manufactured homes that we're building, and that's why we've been focused so hard on building up our development pipeline to make sure that today, we're the largest builder of MH in Australia, and we want to continue that position moving forward.

We've got a question here on velocity, but I'll adapt it as well so you can both participate in the question. The question is -- I suppose I'll start off with Simon, and I'll adapt it for Mark. But do you expect the low interest rate environment and inherently low mortgage repayments to adversely impact demand in the MH sector given the anticipated recovery of the residential market? That's for you, Simon, and then I'll do Mark afterwards. Obviously, another 25 basis point rate cut yesterday, we've had 2 of the majors pass it on in full. How have you historically seen the market react to those rate cuts? And how -- I suppose, how long is the lag between rate cut and then response in volume? Simon?

Yes. So from our perspective, our typical resident is moving in at the age of 67. They're staying with us for 16 years. Outside the equity they have in their former family home, they have very little capital. So the falling interest rates, whilst it does impact the returns they're getting on their savings, the vast majority of their income is coming from the pension. So they're really sort of agnostic to where interest rates are. I do think lowering interest rates helps the first-time buyers and upgraders who are typically buying their homes. And broadly, from my experience, the key determinant on demand is really how -- what -- where the consumer sentiment is at the moment. It doesn't take a lot to spook our prospective customers and for them to stop coming out to our open home. So I guess, the more positive the mood in the community is, the better for us for business. So overall, I would say that lowering interest rates doesn't really have any impact on our business.

Mark?

So -- and I'd agree with Simon. I think the manufactured housing space has a different point of affordability because you're not having to obviously pay for the land. And the federal government helps qualifying over-55s to pay that land lease. So I think that's fair. In terms of how long it takes to translate for an interest rate in our business. I mean it does vary, but we always see a positive reaction if rates are cut. And employment levels are quite high at the moment. Employment growth is high, unemployment is low. So outside of all the macro concerns, generally, from what we can see anyway, buyer confidence is quite reasonable. So we haven't got yet to measure. We'll see on the weekend coming up how people are responding. But based upon the cuts that have already happened and -- in Sydney, since the rate cuts, inquiry levels are up by over 300%.

We'll invite you to the rapid fire another time. Thanks, gentlemen, for joining us. And thanks, everyone, for coming on.