Kiwi Property Group Limited (KPG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Kiwi Property Half Year Results Announcement. [Operator Instructions] Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, to Mr. Clive Mackenzie, CEO. Thank you. Please go ahead.

Good morning, everyone, and thank you for joining us for the half year results announcement for Kiwi Property for the 6 months ended September 30, 2020. And I'm Clive Mackenzie, the CEO of Kiwi Property; and today, I'm joined by our CFO, Gavin Parker. I assume you all have a copy of our presentation in front of you. If not, you can access one from the half year results section of our website at kiwi.co.nz. I'll take the disclaimer as read, so please turn to Slide 3 and we'll run through the agenda. The last 6 months have been unlike any other Kiwi Property's history. COVID-19 has disrupted the world around us and has had a significant impact on our business. Despite this external volatility, the company has remained resilient, adapting to the new normal operating environment and achieving success in a number of areas in the process. We have taken important steps forward on our mixed use journey and continued progressing the diversification of our asset base. We'll begin today's presentation with a recap of some of these highlights before providing an overview of our half year performance and then open the lines for questions. A quick reminder that as usual, we have included detailed financial and property slides and the tenancies to this document. Now please turn to Slide 5. I want to start this morning's presentation by calling out a few key metrics that provide a snapshot of our performance over the half year. As you can see here, operating profit was down 8.4% to $55.2 million. This is due to the impact of COVID-19 and the cost of providing rent relief to tenants following the level 3 and 4 lockdowns. In contrast, the fair value of the company's property portfolio experienced an $11.8 million fair value gain following the revaluation of our investment portfolio at September 30. Encouragingly, capitalization rates have firmed, contributing to the stabilization of asset values. This valuation uplift contributed to an increase in net profit after tax for the period, which rose 47.5% to more than $54 million, a positive outcome given the challenging trading conditions earlier in the year. Beyond the financial metrics, one of the clear highlights over recent months has been the opening of the 57 store level 1 expansion at Sylvia Park. The successful launch of this exciting development reinforces Sylvia Park's position as New Zealand's favorite shopping center. The final figure on the slide is the 2021 interim dividend, which has been set at $0.022 per share, following a stabilization of trading conditions. We now also have sufficient certainty to provide full year AFFO guidance and will outline these details later in this morning's presentation. Please turn to Slide 6. As many of you have heard me discuss before, we have a 3-pillar strategy for navigating the current COVID-19 period. That positions the business to address current challenges in the market and be ready to take advantage of the opportunities that lie ahead. The first pillar of the strategy is about stabilizing our business and supporting our tenants to do the same. It also includes ensuring operational excellence and best-in-class asset management. The second strategic pillar centers on diversification. We've spoken at length about our mixed-use strategy, and we continue to regard this as an area of competitive advantage. Our significant landholdings at Sylvia Park, The Base, LynnMall and Drury are well suited to intensification with a range of asset types. We are focused on decreasing our exposure to pure retail and increasing the weighting of other asset classes, including office and residential. The third longer-term pillar of our strategy is about driving growth, particularly across our mixed-use assets through a combination of divestments, joint ventures and funds management. We see significant opportunities in this space and exploring a number of options. Given the continued uncertainty in the market, it's vital we're highly disciplined about the opportunities we pursue. That means being smart with our capital, prudent with our partnerships and discerning about fund management strategies. Moving now to Slide 7. COVID-19 had a significant impact on the company. However, by taking a number of proactive measures, we have been able to mitigate the pandemic's financial impact. As outlined at our 2020 full year results, these actions included our directors and executives taking a temporary pay cut. When coupled with the $1 million wage subsidy we received, these steps enabled us to retain all our employees through the COVID-19 period. In addition, nonessential projects and operating expenditure were suspended while the Board also made the difficult decision not to pay a full year dividend. This was not a decision they took lightly, but it was necessary in order to safeguard the business at the height of the lockdown. Finally, we worked closely with our retailers and SMEs to share a fair proportion of the financial impact caused by COVID-19. By providing assistance, we increased the likelihood of them and us being in a strong position post pandemic. The cash cost of the rental abatement and deferral measures provided to tenants in the first half of the financial year was just over $17 million. The expected full year cost of the support package remains within the $20 million provision previously outlined by the company or approximately $14 million after tax. That's around 8% of the total income earned by Kiwi Property in 2020. From a financial reporting standpoint, the pretax income impact for the rent relief package was $8.1 million in the first half of the financial year, with the balance to be spread over the remainder of the lease terms. From an AFFO perspective, however, the full impact has been taken in the current period. These rent relief costs will be partially offset by the reintroduction of depreciation allowances for commercial buildings, which is expected to increase our full year earnings by approximately $4.5 million. Turning to Page 8. Kiwi Property's tenant portfolio is increasingly resilient to the impact of future lockdowns. As you can see from the chart on the left, around 50% of our tenants are designated as either essential services or everyday essentials. Many of these businesses can operate effectively at more restrictive alert levels. Our retailers have also developed their omnichannel capabilities so they can keep trading even if lockdowns occur. In addition, only 2 of our tenants contribute more than 5% of gross income, and around 70% of our top 20 tenants provide essential services, contributing to a diversified and resilient rental stream. Turning to Page 9. While COVID-19 has been a central theme through the half year, it's not the only one. In parallel, one of the highlights of the period has undoubtedly been the opening of 20,000 square meter Sylvia Park Level 1 expansion on the 15th of October. The $277 million development features an extensive lineup of local and international brands, including a 2-level farmers flagship store and the Terrace at Sylvia Park Dining Precinct. Following the new addition, Sylvia Park is now home to 10 of New Zealand's 11 favorite retailers as well as more than 250 stores and over 5,000 free car parks, the most of any shopping center in the country. The successful launch highlights Sylvia Park's standing as New Zealand's favorite shopping center and demonstrates its appeal to both retailers and their customers. Moving to Page 10. We have continued to make solid progress against our strategy through the first half of the financial year, with a focus on diversifying our asset base. Design of Sylvia Park Tower 2 is ongoing, with resource consent granted for the 15-floor office and potentially hotel development. In parallel, planning is also underway for Sylvia Park Tower 3, a smaller 6-floor office building, likely to have a substantial medical presence. Encouragingly, both buildings are attracting strong interest from potential tenants. This two-pronged development approach offers significant optionality and ability to move ahead with either or both of the office developments according to market conditions and tenant demand. In this environment, our ability to be agile and adapt to new opportunities will be more important than ever. In October, we took an important step towards reducing our pure retail exposure by initiating the sale process for The Plaza shopping center in Palmerston North. The asset is currently being marketed and has attracted good initial interest from a mix of institutional and high net worth investors. It's still early in the process, however, and we'll provide further updates to the market at the appropriate time. This potential disposal will unlock capital to fund our development pipeline. Almost as importantly, though, it also demonstrates the company's commitment to diversification and gives clarity to the market about our strategy and long-term direction. Finally, we continue to make good progress on build-to-rent, with the design of the first scheme significantly advanced and resource consent applications submitted to council. We're hoping to share the specifics of the scheme with you early next calendar year. The residential market continues to grow at a rapid pace. COVID-19 has seen more Kiwis coming back from overseas, who are used to living in rented apartments. In parallel, rising house prices are resulting in a growing number of Aucklanders being pressed out of the market. As a result, we continue to see significant upside in build to rent. On to Page 11. ESG is a key area of focus for Kiwi Property. Earlier this year, we announced a 50% reduction in greenhouse gas emissions compared to our 2012 baseline, and we were proud to be the top-performing New Zealand company on the Carbon Disclosure Project's climate action list. It's clear that sustainability is becoming increasingly important to our stakeholders, including our consumers, tenants and investors. With corporates being held to an increasingly high standard, we believe it's important for Kiwi Property to continue lifting its ESG game. With that in mind, we established an ESG board committee in April, charged with overseeing the business' response to the opportunities and challenges created by issues such as climate change. We will be releasing new ESG strategy, featuring several new signature programs early next year, and in parallel, publishing a comprehensive annual ESG report designed to make it even easier for the market to evaluate our environmental, social and governance performance. Turning to Page 12. Now that trading conditions have stabilized and we have a clearer picture about the economic climate, we're pleased to be in a position to pay an interim dividend for the period ended September 30. In line with our new dividend policy, the payment has been set at 95% of AFFO or $0.022 per share and will be paid on the 18th of December. Today, we're also providing full year AFFO guidance of $0.049 per share to $0.515 per share, contingent, of course, on the full year results and barring material adverse effects or unforeseen circumstances. While there's still some volatility in the market, we hope this forecast offers investors a degree of certainty about Kiwi Property's trajectory and gives them confidence in the business performance going forward. That's a snapshot of some of our business highlights over the past 6 months. Let's now take a look at our half year financial results commencing on Slide 14. As you can see here, net rental income reduced by 5.3% to $84.9 million due to the cost of COVID-19 rental abatements. While office income grew 2.5% for the period, mixed-use and retail were harder hit, decreasing 9.8% and 16.2%, respectively. AFFO was also affected by the cash impact of the COVID-19 rent relief measures, contributing to a 21.1% decline to $36.5 million. On a positive note, as I mentioned earlier, net profit after tax rose markedly through the half year, increasing 47.5% to $54.2 million. Moving to Slide 15. While providing rent relief to our retail and SME tenants' impacted net rental income and AFFO figures at the half year, in parallel, it has helped the company to maintain its healthy portfolio of tenants. Over the last 6 months, rents grew 1.5% overall, with rent reviews up 3%. These were partially offset by reversions on a relatively small number of new leases, which experienced a 10% decline. The decrease in mixed-use and retail leasing spreads is largely due to a short-term deal with a retail chain currently in receivership. With a reduced number of deals conducted during the period due to COVID-19, this agreement had an outsized impact on the new leasing metrics but enables us to keep the tenancies full while they're being repurposed. Despite the COVID-19 headwinds, our portfolio remains 99.1% occupied, while the weighted average lease expiries sits at a healthy 4.7 years. Moving on to Slide 16. Unsurprisingly, retail sales and pedestrian count declined for the period, with a number of stores unable to trade during the level 4 lockdown, in particular. Total MAT is down 9.1% on the previous period, with shopping centers heavily affected by COVID-19. To help provide a more accurate comparisons against the prior period, we also calculated the adjusted sales based on actual days stores were able to trade to help eliminate some of the lockdown impact. A high-level snapshot is showing here with more detail available on Slides 36 to 39. As you can see, on an adjusted basis, sales are largely in line with totals for the year ended February 2020, with large-format retail tracking marginally ahead. Encouragingly, this suggests traders held up well despite strict limitations on how certain retailers could operate. Gross occupancy cost ratios increased for the period but remained low, providing a useful buffer for tenants under pressure in the new operating environment. Turning to Slide 17. On the capital management front, the company completed $361 million of bank debt extensions in the period. The company's weighted average cost of debt decreased from 4.35% to 4.29%. In parallel, our weighted average term-to-debt maturity contracted slightly from 3.9 years to 3.4 years. Our credit ratings remain unchanged. On to Page 18. The company's investment portfolio was worth $3.2 billion at September 30, 2020, up from $3.1 billion at March 31. While the uncertainty caused by COVID-19 continues to impact property valuers' assumptions, the valuations undertaken at September 30 suggests a general stabilization of asset values and an encouraging firming of capitalization rates, which firmed an average of 11 basis points across our portfolio. The positive movements in our portfolio value also contributed to a favorable improvement in our gearing ratio which decreased to 31.8% and remains well within our self-imposed target range of 35 -- sorry, 25% to 35%. Net asset backing per share is $1.29, up from $1.26 at the end of the prior financial year. Now to Page 19. Funds from operations was $0.354 per share, declining 1.7% on the prior comparable period. AFFO per share was also down, decreasing 27.6% due to the cash cost of COVID-19 rent abatements and deferrals as well as the increased weighted average number of shares on FFO on the November 2019 equity raise. While AFFO has experienced a material reduction, we are squarely focused on driving a normalization of this metric. While the strict lockdowns have affected the company's AFFO in the first half, with the country now adept at responding to COVID-19, we are optimistic future responses will be less restrictive. Please turn to Page 20. As we enter the second half of the financial year, we have a clear set of strategic priorities that will underpin Kiwi Property's performance over the coming months. Firstly, we will continue to drive for stability in our operations, mitigating the impact of COVID-19 and working with our tenants to maintain a robust tenant portfolio. In parallel, we will enhance our retail mix, concluding negotiation, with exciting new tenants for the adventure precinct at Sylvia Park. Secondly, we will continue diversifying our asset portfolio, progressing the disposal of The Plaza and the design of Sylvia Park's, Towers 2 and 3, and build to rent. And finally, we'll foster growth, advancing the Drury private plan change to enable a faster project time line and recycling capital to fund our exciting and ambitious development program. As I said at the start of my remarks today, the first half of the financial year was unlike any other in the company's history. Despite the issues caused by COVID-19, however, the business has remained resilient. The coming months will invariably bring their own complexities, but Kiwi Property is well placed to tackle these challenges, with a commitment to creating a value -- the commitment to creating value for our stakeholders. I'd like to thank you all for joining today. That concludes my overview of our 2021 half-year results. I'll now hand over to the moderator, who will open the phone lines for your questions. Thank you.

[Operator Instructions] Our first question is from Mr. Arie Dekker from Jarden.

Yes, just starting on the rent relief, to the reversion, I guess, the extent on an annualized basis of the relief you've provided that tenant administration. Can you just give a little bit of color on what the quantum of that is and what the length of time that deal has been done for?

Yes, sure. Yes, look, it was an actual tenant that we had at across 5 of our shopping centers. The -- it made prudent financial sense for us to grant a short-term extension of approximately a year to the receivable of that tenant to allow us to continue to be able to get cash coming in while we're looking to repurpose those tenancies. So that was the strategy behind it.

Sure. I mean, just in terms of -- like I said, so it's a year deal, what sort of has been the dollar quantum impact on rent from that deal? And then also just on that repurposing, is it a year -- do you have an ability to step in yourself in that year and repurpose, if you find yourself proactively -- if you find a new tenant for it?

Yes. So there will be the ability for us to be able to step in as we need to. Just in terms of the quantity, the deal that we did basically accounted for about 79% of the mixed-use decline and a 55% overall of all the rent reversions we have. So there's obviously a significant transaction in terms of reversions of rent, but we feel it as a one-off and it was at a place in time to deal with a situation in the middle of a COVID pandemic so...

How are you progressing with finding a new tenant for that? And do you see yourself putting a new tenant in terms of -- ahead of like the full year?

Look, it's just part of our normal business. Tenant and retail chains close down from time to time and going to receivership from time to time. It's just part of our normal course of business to reformatting and reprogressing those stores, yes. So we don't foresee any issue with that. It's just a normal part of our business.

Sure, okay. And you've got some confidence then also that when you come out the back end of that you'll see rents in that space? You've got confidence in terms of occupancy and the level of rents in that space being broadly in line with what it was previous?

We do.

Okay. Just a bit of color on doubtful debts. I mean, that's sort of gone up sort of just over threefold. I guess in this environment, sort of understandable. Could you just provide a bit of color there in terms of what's behind that increase?

Yes, you'll -- sorry, Arie, it's Gavin here. You'll appreciate it's been quite a glitchy period in terms of rent collections as we've had to work through a significant number of tenants and agreed their abatements. But the actual rent due at September 30 was just under $15 million. We have received about $8.5 million post balance date. So it's already down to about $6.5 million. We've received further payments since then, but they haven't yet been matched, so it's likely that, that number will be even less.

And do you see any scope in on what you've seen post balance date for a reversal out of some of that doubtful debt provisioning?

I can't say at the minute, but we think it's an appropriate provision at this stage. Yes, I just -- in the context of what you've collected post -- yes. Yes, okay. Just turning to Galleria, I mean just leasing status. I know it kind of opened fully committed. In terms of the progress you've made since then, is that -- I mean, are you at the point now where it's fully leased and signed and documented?

Yes. So where we -- and as we I think we've spoken previously, we have commitment from all tenants to use the space. We're basically down to the last tenant, a small tenant of about 80 square meters that we're just finalizing the lease terms with at the moment, and we expect that to be finalized in the next week or so. Some -- as we're speaking, actually, stores are opening all the time, and we expect there will be a handful of stores flowing into next year around Sephora and Mecca and some of the international brands that are backed up and setting up in New Zealand, given obviously, the restrictions on travel at the moment. But our view is that by March, we'll have pretty much everybody up and trading, yes.

Sure. In terms of those ones that still need to complete the fit-out and that sort of thing, is there much space where that just hasn't commenced? Or is it all in progress now?

Well, as I mentioned, some of the stores are actually fitting out and opening as we speak. And the ones that are going to open in the year, they'll start off to Christmas in their fit-out, but the space is ready for them, yes. If that was your question, yes.

Okay. Great. And then just in terms of where you ended up on Galleria and sort of the impact in the valuation, what -- where did you sort of end up development margin-wise by the time you'd sort of incurred some extra costs and likely in relation to incentives in that as well?

Yes, it's very hard to quantify that development margin, Arie. There's a huge number of moving parts in that Sylvia Park valuation. As you know, it quite ahead of March '20. So we can't quantify the development margin, but it's likely been eroded by that March '20 valuation impact.

Sure. And then just the commitments as at balance date, $27 million committed at Sylvia Park, is that almost all related to just finishing off there at Galleria? Or is there anything else meaningful in that $27 million?

If you look at the investment property note in the financials, you can see what Sylvia Park's being valued as of complete and then $45 million of costs have been deducted. So whilst there's only $27 million committed, there's $45 million left to spend on Galleria, and that's just timing of cash flow. The work is done.

So there's nothing else meaningful kind of on the committed development front that is needing to be completed? Yes. Okay, great. And then just lastly for me, just on Office 2 and 3, which you're progressing, can you just provide a little bit more color just in terms of what you're sort of seeing on demand, both for the office or potentially medical office sort of -- and how close you might be to kind of push and go on one or other of those?

Yes, look, and as I mentioned in my presentation, having the 2 buildings under design simultaneously gives us that optionality that, as they come through their design process towards the middle of next year, we'll be able to assess the market conditions and make a call as to which one proceeds or whether they both proceed, depending on market conditions. So -- and they are different sizes, so it gives us some flexibility around what the market is able to cope with at the time. So it's all about making sure we have optionality, and I'm in the best position that we can be when we ready to move next year.

[Operator Instructions] Our next telephone question is from Nick Mar from Macquarie.

A few clarifications. Just on the guidance, what have you assumed in there in terms of potential Plaza sale? Is that concluded in the $4 million range?

Nick, it's Clive here. No, we haven't assumed that in there at all.

Okay. No, that's clear. In terms of the MAT numbers, when you kind of do the days adjustment, how do you guys think about, I guess, the catch-up trades post lockdowns that you would have seen through those centers? Do you think the 0% number is the right number when looking at it on the kind of profit like-for-like?

I'm not quite -- do you wanted just to repeat the question? I wasn't quite clear on what the question was. My apologies.

Yes. So on a days adjusted basis for the MAT, it's flat based on comparable last year. Do you think that's the kind of right number when taking into account some of the catch-up and trading, what would have been seen post lockdown, so stronger sales for a number of days, given people have been locked away for kind of 1.5 months?

Yes. Look, as I mentioned in my presentation, for the period from the beginning of March through to now, actual sales were down 9.1%, but we wanted to bring some adjustment to that to give people a chance to compare it to prior year. And on an adjusted basis, which is detailed in the notes how we did that adjustment, it actually comes up -- it's basically flat to slightly ahead of last year. Look, it's really hard to compare between the 2 periods, to be honest, but what we're seeing on the ground is that the sales have rebounded. And I think that's probably the message that, given the opportunity, people are going back and spending, and that's the positive outcome to take from that, yes.

Cool, and then given that things have rebounded, where do you think that re-leasing spread should be on a go-forward basis?

Look, the one thing I will say is that there is some sensitivity as soon as there's talk of any community transmission. The pedestrian council in the centers are super sensitive to that. And I think retail will be sensitive until we're able to see a resolution of COVID-19. And that's just -- you can see that globally, and that's -- New Zealand is no different from that. The good news though is that New Zealand has covered reasonably under control at the moment, and our retailers have become much more resilient at learning to trade with a limited lockdown basis, which the government uses on at levels 2 and 3, yes.

Yes. So my question was, what do you think re-leasing spread should do given that trading's broadly rebounded?

Well, I think what will happen is, as retailers get confidence and as we're coming into any additional lease-ups that we have to do or relettings that will give us and then the confidence to be able to set rentals going forward at an appropriate level based on those sales.

Okay. So just to be clear, do you think an appropriate level is minus 9% as you saw in mixed use? Obviously, you've got to adjust for the national retailers. So trying to get some clarity on where you think that should land.

It's probably too hard to make a call at the moment. But obviously, we'll be striving to grow rent, not decrease rent. So there's that natural tension, but it's going to be dependent on how sales continue to grow and how Christmas goes, et cetera, yes.

Okay. Can you just talk through what happened with the base valuation at the half? Cap rates were a bit down significantly.

Yes. Look, across our portfolio, you'll be aware that seismic has something -- seismic conditions are something that we assess on an ongoing basis. And we needed to make some provisions at the base for some seismic work. We feel at the very early stages of just starting to undertake some design work around what remedial work we need to do. And as that information comes to hand as we go forward, we'll be able to quantify exactly what, if any, potential cost they will be at that center. So there was a bit of a seismic adjustment, but we're planning to work through that over the coming months.

Our next telephone question is from Adam Lilley from Craigs Investments.