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

Good day, and thank you for standing by. Welcome to Kiwi Property FY '23 Interim Results Webcast. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, sir Clive Mackenzie, CEO. Please go ahead.

Thank you, Durham. Kia ora everyone, and good morning, and thank you for joining us for Kiwi Property's interim results announcement for the 6 months ended 30 September 2022. I'm Clive Mackenzie, the CEO of Kiwi Property and today, I'm joined by our CFO, Gavin Parker; and our Head of Investor Relations, Cam Hodgetts. I assume you all have a copy of our presentation in front of you. If not, you can access one from the Annual Results section of our website at kp.co.nz. A quick reminder that as usual, we have included detailed financial and property slides in the appendices to this document. I'll take the disclaimer as read. So please turn to Slide 5. As you're all aware, we are operating in a challenging economic climate; high inflation, rising interest rates and a labor supply shortage has created significant uncertainty in the market. During this volatile period, the delivery of our strategy is more important than ever. Our evolution from a retail and office landlord to the creator of connected communities continues to gain momentum. While this transition will take time, as you'll hear today, we sustained a robust operating performance over the past 6 months, while taking the business closer to our goal of becoming a developer, owner and operator of mixed-use assets at key metropolitan centers and transport hubs. We believe that by intensifying our mixed-use assets, leveraging diverse capital sources, enabling the success of our customers and driving operational excellence will be in the strongest position to grow shareholders' returns. Turning to Slide 6. Kiwi Property's active leasing and asset management platforms are a source of competitive advantage and have enabled us to maintain highly productive assets despite the impact of COVID-19. You will recall the consistent rental and sales growth delivered across our portfolio over recent periods and we're proud to have maintained this positive trajectory. During the 6 months to 30 September, Kiwi Property earned NZD 100 million in net rental income, marking a new record for the company. Despite concerns about the macroeconomic climate, we grew rents by an impressive 4.9%, while continuing to keep our high-quality asset portfolio almost fully occupied. Sales across our mixed-use and retail assets were up nearly 10% on the same time last year with the Sylvia Park precinct alone, generating more than NZD 750 million in sales over the past 12 months. Importantly, we achieved all these milestones while continuing to improve the quality, resilience and sustainability of our assets. Our focus on ESG was rewarded with the GRESB score of 81 for the year, placing us amongst some of Australasia's most successful REITs. These figures are testament to the strength and resilience of our assets. As we've been saying for some time, flagship retail destinations are continuing to go from strength to strength, even as second-tier assets come under pressure. Data released by NZ Post at the start of November showed that with Kiwis now settling into a post-pandemic norm, there's been a shift from online to in-store shopping. Online spending fell for the second quarter in a row and is now below where it was 2 years ago. At the same time, in-store spending is now 14% above pre-pandemic Q3 2019 levels. Discussions about the future of retail often overlook the fact that not all retail is the same and it shouldn't be viewed as such. We're proud to own and operate some of New Zealand's best shopping destinations, putting us in the driver's seat to benefit from retail's clear bifurcation. Moving to Slide 7. We made significant progress on our targeted development program in the first half, bringing Sylvia Park's transformation into a world-class mixed-use community ever closer to fruition. Construction of the precinct's 295 build-to-rent apartment complex is moving forward at pace with the steel superstructure now up to 3 levels high in some places. This exciting project will help embed Kiwi Property as a leader in BTR in New Zealand and help us to capture the financial benefit that we believe will flow from the new asset class over time. Elsewhere at Sylvia Park, the new 6-level medical and office development at 3 Te Kehu Way is advancing with similar momentum. The building's exterior is now complete with its innovative and distinctive design already becoming a prominent feature on the Mount Wellington landscape. Internal fitouts are now underway at 3 Te Kehu Way and is on track to be completed in the first quarter of 2023, marking the next step towards the creation of a thriving commercial precinct at Sylvia Park. Around 2/3 of 3 Te Kehu Way's net lettable area is either committed or subject to advanced negotiations with an impressive lineup of tenants in place, including Tamaki Health, Horizon Radiology, Geneva Finance and co-working operator, IWG. In addition, the redevelopment of Sylvia Lane was recently finished, creating an exciting new all-weather dining precinct. Sylvia Lane is set to become a cornerstone of the center's entertainment offering, providing an attractive place for people to eat, drink and socialize. The enhancement of Sylvia Lane is expected to drive customer and tenant demand, helping to generate sales and ultimately, rental growth. Turning to Slide 8. In early November, Kiwi Property's Drury Private Plan Change was approved by the Environment Court, confirming our landholding as the site for the future Metropolitan Town Center. Stage 1 earthworks are now underway at Drury, marking the next step in Kiwi Property's ambition to create a 6 green star transit-orientated community south of Auckland. The earthworks are expected to take 2 years at a cost of around NZD 30 million. Pleasingly, the up zoning of our Drury site has already delivered valuation gains with the landholding now worth more than double the purchase price and expected to increase further once earth and civil works are complete. With the Private Plan Change now secured, we've also resumed the fast-track consenting process with the goal of accelerating resource consent and facilitating the creation of 13 residential super-lots. The potential sale of these super-lots will enable us to realize returns from the project and assist with future funding. Moving now to Slide 9. The disposal of noncore properties and subsequent recycling of capital is a central pillar of our funding strategy, and we've made important strides on this front in the 6 months to 30 September. Today, we announced the unconditional sale of 44 The Terrace in Wellington for NZD 48 million with NZD 2 million retained for seismic costs. The transaction is expected to settle on 15 December 2022 and delivers a property level IRR of 12.2% from inception. Westgate Lifestyle has also now been listed for sale following the disposal of Northlands Shopping Center in Christchurch for NZD 151 million net of seismic costs, which is due to settle on 30 November 2022. The proceeds raised from these transactions will be used to repay debt and fund our development pipeline, delivering what we believe will be better long-term value for shareholders. One of our business' strength is this large strategic landholding, including more than 125 hectares across our mixed-use assets at Sylvia Park, LynnMall, The Base and Drury. This landholding provides an extensive range of options and provides the flexibility to dictate the timing and speed of our development activities. We currently have around NZD 217 million of development expenditure remaining at 3 Te Kehu Way and Sylvia Park build-to-rent. We are proactively managing pricing and expect both projects to maintain the target yields that were previously disclosed to the market. While these developments and the Stage 1 earthworks at Drury present exciting opportunities for Kiwi Property, we'll maintain a cautious approach to the timing of further activity. New developments will only occur when market conditions, costs and return metrics are acceptable. Our priority is to ensure the right financial conditions and suitable funding are replaced before any further construction projects begin, so we're making the best use of shareholders' capital. Turning now to Slide 11. Kiwi Property posted a strong operational result in the first half of the FY 2023 financial year, delivering growth in key metrics such as sales, rental income, operating profit and adjusted funds from operations. As I've already mentioned, net rental income rose to a record high of NZD 100 million, up 6.3% on the same time last year, driven by a sustained revenue uplift at Sylvia Park in particular. Operating profit after tax was also up, increasing 4.2% to NZD 65.1 million, reflecting the pleasing performance of our diversified asset portfolio. AFFO rose 35.8% to NZD 65.2 million, assisted by the release of COVID-19 rental abatement accruals, which were not required. The company's robust operational result was unfortunately unable to offset the impact of rising interest rates and the global softening of capitalization rates. As a result of these headwinds, the fair value of Kiwi Property's investment portfolio declined by an unrealized 5.8% or NZD 213.3 million, causing the business to post a net loss after tax of NZD 151.1 million. While the decrease in fair value of our property portfolio and subsequent impact on net profit is disappointing, it's not unexpected given the well-documented challenges facing the global economy. By actively managing our assets and tightly controlling our cost base, we will be in the strongest position to maximize asset values going forward. On now Slide 12. The company continued to drive strong rental growth during the period, including a 4.9% increase in new leases and rent reviews across our office and mixed-use portfolio. Our ability to increase rents, while simultaneously securing our pipeline of new tenants is a testament to the demand for space in our assets led by Sylvia Park, LynnMall and The Base. This demand enabled our portfolio to remain almost fully occupied at 30 September and achieved a robust weighted average lease expiry of 4.6 years. Turning now to Slide 13. Retail sales continued to bounce back strongly post COVID-19, with the reduced Auckland lockdowns enabling stores to trade for 13 more days than they did in the preceding 12 months. Total sales were NZD 1.51 billion on an MAT basis, up around NZD 280 million on the prior comparable period, a very good outcome considering cost of living pressures currently facing Kiwi consumers. Total sales growth was an impressive 9.6% on the prior year across our mixed-use and large-format retail centers combined, while specialty sales at our mixed-use shopping centers increased to NZD 12,900 a square meter. Especially, gross occupancy costs were 12.1%, a favorable position compared to many Australasian REITs, highlighting the highly productive and well-placed nature of our retail tenancies. Turning to Slide 14. Kiwi Property undertook several capital management activities in the first half of the financial year, including increasing our bank debt facilities from NZD 850 million to NZD 950 million. Post the reporting period, our bank debt facilities were increased to NZD 1 billion and the weighted average term of all debt facilities was extended to 4.1 years. In line with most of our listed property peers, we have also granted mortgage security in respect of our properties and increased our bank gearing covenant to 50%. The weighted average cost of debt grew from 3.85% to 4.41%, driven by the increased interest rates that have been a recent feature of the international and domestic economies. Turning now to Page 15. Maintaining a robust and flexible balance sheet is a priority for the business in the current market. The previously mentioned unrealized reduction in the fair value of our property portfolio, so our gearing increased to 35.7% as at 30 September 2022. Net asset backing per share was similarly affected, decreasing to NZD 1.31 per share. It's important to note, however, that once our gearing figure is adjusted on a pro forma basis to reflect the settlement of Northlands on 30 and 44 The Terrace on 15 December, pro forma gearing decreases to approximately 32%. Now to Slide 16. Kiwi Property will pay a quarterly cash dividend of 1.425 cents per share, taking the year-to-date interim cash dividend to 2.85 cents per share, up almost 4% on the prior period. Today, we are pleased to confirm our full year dividend guidance at 5.7 cents per share, representing a gross dividend yield of 9.3% based on the current share price and assuming a 33% personal tax rate, while enabling us to retain earnings to fund growth. As always, it's important to note that the payment of any further dividend is contingent on the performance of the company through the remainder of the 2023 financial year and barring material adverse effects or unforeseen circumstances. On now to Slide 17. As you have seen, Kiwi Property delivered a strong operating results in the first half of the 2023 financial year and took important steps forward in the delivery of our strategy. As we head into the second half of the financial year, we have 4 specific priorities. First, we'll strive to maintain balance sheet flexibility and capacity through a combination of cost control, capital recycling and strict financial discipline. Second, we'll advance the Stage 1 earthworks at Drury and move forward with the fast-track application, taking us closer to having the option of selling down super-lots in order to release capital. Third, we'll continue pushing forward with a dedicated leasing programs at 3 Te Kehu Way with the aim of having all tenancies committed in time for opening. And fourth, we will continue to drive operating excellence across our high-quality asset portfolio with a focus on growing rents, maintaining high occupancy and working alongside our tenants to achieve sales growth. While we're cognizant of the macroeconomic environment, we're focused on the factors within our control, delivering on strategy, intensively managing our assets, seeking out opportunities to benefit from the current market volatility and striving to grow the share price. Before I wrap up for the day, allow to add one final thing. Today will be Gavin's last results announcement after 20 years with the company. He has been an excellent CFO and a trusted adviser to me, our Board and management, and I want to wish him all the very best for the future. We're well advanced with our recruitment for Gavin's replacement, and I look forward to making an announcement on that front shortly. Thank you all for joining today. And that concludes my overview of our interim financial results. I'll now hand over to the moderator, who will open the phone lines for questions. Thank you.

[Operator Instructions] Our first question comes from the line of Arie Dekker from Jarden.

Just first question, it may be in the detail, but I couldn't find it. Could you just say what Westgate Lifestyle's book value as at first half 2023?

Yes, it was NZD 50 million.

No, Westgate Lifestyle.

Sorry, Westgate Lifestyle. Sorry, I thought you mentioned 44 The Terrace. My apologies, yes.

The value at 30 September, Arie is...

I think it's NZD 95 million.

NZD 95 million.

Yes, NZD 95 million.

Yes, okay. So consistent with FY '22. And just on 44 The Terrace, the cap rate at first half '23?

6.38%

6.38%. Just on 3 Te Kehu Way, which is obviously nearing completion, what's the commitment level versus advanced negotiations? I think the commitment was around 30% at full year.

Yes. So commitments are just under 60% at the moment.

That's good. Near 60% here. And in terms of -- I mean, obviously, going into the break on that as well, but you've sort of got enough in progress that you think there's a decent chance that you'll be pretty close to fully leased up at completion?

Yes, absolutely. That's the objective. And we're very pleased to see the level of interest from medical office tenants and medical tenants, which was one of our objectives. So we're seeing that momentum carry forward as well, yes.

Yes, I guess it's getting critical mass. That's good. Just on one-off costs, are they going to feature again in second half '23? Or is that, the NZD 2 million-odd only first half?

Certainly, the ERP costs will feature in the second half, Arie because that's sort of a circa 2-year project. So they will feature in the second half. The first half also included some costs for our office platform, which we've expensed in the first half.

So just to get a bit of a sense of it, would the ERP costs in the second half, would they sort of be roughly half of what would the one-off costs called out in first half? Or is it less than that?

It would be at least that, I would say.

And then just final one. I mean, obviously, you've talked to new developments and market conditions and that sort of thing. I mean would it be fair to say that as things currently stand, that there's nothing sort of new that you would be anticipating to commit to in the -- end of the year '23?

Yes, that's correct. Other than what we've already announced, yes.

And then just on the NZD 30 million for Drury, is that committed? Or do you still have flexibility on that, it's not committed?

Well, we -- obviously, we've got the earthworks underway at the moment, but we can stop at any point here. So we can slow it down.

Yes, and it is a 2-year program.

It is a 2-year program, yes.

And then just on -- in terms of funding, outside of Westgate Lifestyle, there's nothing else planned for divestment at this point?

Not immediately, no. No. We're constantly looking at our portfolio to see what are strategic assets for us as we move forward. So that process will continue. But obviously, we're well advanced with the asset sales that we've called out, yes.

And our next question comes from the line of Nick Mar from Macquarie.

Just turning to the guidance. Is there much to read into the change of wording from sort of no less than 5.7 cents to just 5.7 cents? And just sort of in the context of the fact that it was a pretty strong first half of AFFO, do you still expect to be within the 90% to 100% range at a full year basis?

No, there's nothing in it, Nick. I mean, obviously, we're conscious of the yield that we're currently providing. And so we're firming up guidance at 5.7%. Obviously, AFFO will be more than that. The 90% to 100% payout is used as a guidance. And last year, we came in, I think, at 88%, and we'd expect to come in under the 90% this year as well. I mean, obviously, it makes sense to retain earnings given our current yield and our development pipeline. It just makes sense to withhold that -- retain further earnings.

Are there any sort of lumpier numbers to come through in the second half? Obviously, maintenance incentives were quite low in the first half. COVID is sort of a slight positive inflow. And any sort of depreciation recovered or cost by debt on the asset sales that will settle?

Yes. You've called out the 2 obvious sort of, I guess, one-off benefits in the first half, which is the abatements that were not required, which have been reversed to AFFO and also maintenance CapEx in the first half was lower than expected or what you'd expect in the second half. So they won't feature in the second half. Although, you'll see in the abatement slide in the pack that we're still carrying NZD 1.4 million in the footnote, NZD 1.4 million, further abatement accruals. We've got the final handful of tenants to resolve, but I would expect that we won't necessarily require all of that NZD 1.4 billion. So there might be a little bit more to shake out in the second half.

And just in terms of the commentary around development, you mentioned the return metrics are unchanged in terms of the yield on cost. Is there a cost creep offset by better rents in any of those projects? Or are there projects within cost?

Yes. There's a bit of that. Obviously, there's cost pressure coming through. I mean it's affecting every project out there. But we're fortunate that we're seeing rising income on the other side to offset those. So at the moment, they remain in balance, yes.

So what would the total project cost now be on the build-to-rent?

We haven't got an update for the market on that number at the moment, yes.

And then just on the gearing covenant, it sort of increased, which is sort of in line with the sector, but the bond one remains at 45%. How does that work having 2 different numbers?

Yes, that's right, Nick. So as I said, there's sort of provision or transitional arrangements. So in effect, the banks benefit from the bond covenant at 45% unless we go to bondholders and seek to increase the bond covenant to 50% as well. There is some -- effectively, it's an event of review rather than event of default So yes, it's 50% until -- sorry, it's effectively 45% until the bonds either roll off or the bond covenant is amended.

[Operator Instructions] And I show our next question comes from the line of Bianca Fledderus from UBS.

Firstly, just following up on new development commitments. So you mentioned these will only occur when return metrics are acceptable. Are you able to share what sort of return metrics you are looking for in the current environment to make new developments, except towards sort of the medium term?

No, we don't have an update for the market on that at the moment. Look, there's a lot of uncertainty around cost prices coming through from the construction sector. There's a lot of uncertainty on interest rates, inflation, et cetera. So yes, this is not -- from our perspective, this is the time just to be cautious and not to rush into any new developments.

Okay. And then just with regards to the first month of trading of the second half, are you starting to see any sort of negative impact from cost of living pressures, especially your mixed-use and retail assets? Any sort of comments around that?

Not at this stage. And in fact, we just had the Black Friday weekend that just went through, and I can let you know that the sales were very strong and comparative to pre-COVID levels as well. So that momentum is carried on. Yes. So yes, we haven't seen any pullback at this stage, yes.

Okay. And I guess just following on from that, GOC, that was a good improvement, obviously, compared to the same period last year. I guess that is sort of a hard measure to forecast or do you expect GOC will likely increase further or sort of stabilize around that 12% level?

It's a hard one to predict, depending on what happens in the economy and how the consumer reacts. But at this stage, we aren't seeing any change to that. So look, it allows us quite a large buffer, a, to grow income over time, but also in case the economy really deteriorate significantly, there is a buffer for our retailers as well.

I'm showing no further questions in the queue. At this time, I'd like to turn the call back over to Clive Mackenzie, CEO, for closing remarks.

Thank you, everybody, for joining. I appreciate your attendance this morning, and we look forward to catching up soon. Thank you. Bye.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.