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

Good day, and thank you for standing by. Welcome to Kiwi Property Financial Year 2023 Annual Results Conference Call. [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, Steve Penney, Chief Financial Officer. Please go ahead, sir.

Thank you, [ Joda ]. Good morning, everyone, and thank you for joining us for Kiwi Property's annual results announcement for the year ended 31 March 2023. I'm Steve Penney, the CFO of Kiwi Property. Our CEO, Clive Mackenzie tested positive for COVID yesterday and he's losing his voice, so I'll be giving today's opening remarks. Clive has dialed in remotely and will be participating in the Q&A portion of this webcast. We're also joined by our Head of Investor Relations, Cam Hodgetts. I assume you 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 the annual results presentation. I'll take the disclaimer as written, so please turn to Slide 5. I want to begin today by talking about our strategy for creating value for our shareholders and other stakeholders. The core of the strategy has remained consistent for several years, and we continue to strongly believe that by becoming New Zealand's leading creator and curator of mixed-use communities, we will be in the best position to deliver for our shareholders through the short, medium and long terms. Over recent months, however, we've made minor refinements with the aim of building a business that's higher performing and better equipped to deal with the evolving operating reality we now face, including a greater requirement from investors around ESG and the acceleration of digital. 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 will hear today, we achieved a robust operating performance over the past year, while simultaneously reshaping our portfolio and moving the business closer to our goal of becoming a developer, owner and operator of mixed-use assets at metropolitan town centers. We have 4 strategic pillars that will drive the company forward in FY '24 and beyond. The first of these, and surprisingly, is to lead the market on mixed use. By aggregating a range of property types on one site, we will create a competitive point of difference for Kiwi Property while enhancing the performance of our assets, resulting in more resilient valuations and greater shareholder value. The second of our strategic pillars is to grow with diverse capital sources by recycling capital and partnering with a broad set of investors, we will help grow our assets under management and reposition the business for higher quality, lower risk earnings. Next, we will enable the success of our customers and partners by creating and curating market-leading property assets and strategic long-term relationships. And finally, the fourth pillar of our strategy is to build a future-fit business. We'll do this by driving operational excellence, harnessing the power of digital, leading on sustainability and building a high-performance culture. Let's take a look at some of our strategic successes in FY '23, beginning on Page 6. Kiwi Property delivered robust growth across many of our key metrics in FY '23. One of the most pleasing aspects of the result was the significant increase in sales, which rose 28.5% to NZD 1.7 billion. Compared to FY '19, the last full year of trading unaffected by COVID-19, sales were up 34.8% allowing for the Sylvia Park expansion and on a like-for-like basis, sales are up 21.5% since FY '22 and 13.3% since FY '19. These figures highlight the strength and resilience of our flagship mixed-use assets, which recorded 25 million customer visits in FY '23 or the equivalent of almost 5 visits for every person in New Zealand. The strong foot traffic helped drive sales across the Sylvia Park Precinct to a remarkable NZD 889 million in FY '23. It was great to see that Base also breaking through the NZD 500 million sales threshold reflecting a standing as the leading retail center in the Waikato. Turning now to Page 7. We believe that Kiwi Property has one of the best property and tenant portfolios in the country, promoting resilience against macroeconomic headwinds. 53% of our tenants provide essential services. Everyday essentials are government departments or financial service providers considering a high degree of income security even under challenging conditions. As you can see here, our top 10 tenants include a range of blue chip organizations such as ASB, MSD and ANZ. Importantly, none of these tenants provide more than 10% of gross income, offering significant revenue diversification. Our weighted average lease expiry is 4.4 years, allowing us to reset rent, remix tenants and refresh fit-outs for our retailers on a regular basis. Turning now to Slide 8. Drury is one of Kiwi Property's most exciting current opportunities with the private plan change now secured, which designated our site as the location of the future town center. We're moving ahead to create an exciting new mixed-use asset over time. All 13 of the site's residential super-lots are now formed and at grade with titles expected to be issued early in the 2026 calendar year. This is excellent progress, especially considering some of the major weather events over recent months. Kiwi Property isn't the only party strongly committed to Drury. The central government is spending around NZD 500 million a year for the next 5 years to build infrastructure in the area, including the State Highway 1 upgrade and the new Drury Central Train Station. These projects will enhance Drury's accessibility and help supercharge growth across the region. The table on this slide shows the anticipated value that will be created through Drury Stage 1 land development. Additional value could be created if we held land for future improvement or undertook residential office for retail construction. As you can see, at the completion of earth works -- earth and civil works, the gross developed land value of the Stage 1 site is expected to be NZD 205 million. The Stage 2 site will be retained for future development and provides the opportunity to drive significant additional returns. We have a range of options available to fund development at Drury, including the sale of residential super-lots or large-format retail sites as well as joint ventures or external capital partnerships. Please turn to Slide 9. In late March, we completed the new 6 level development at 3 Te Kehu Way. The building has been designed to cater to the needs of both office and medical tenants, the latter of which is becoming an increasing focus for the business due to the sector's forecast income resilience and long-term growth potential. 3 Te Kehu Way's distinctive design has already made it a prominent feature on the Mount Wellington landscape. But even more importantly, the building marks an important step in Sylvia Park continued mixed use evolution with ANZ Raranga right next door, we've established the core of a new commercial hub, providing a platform to attract new tenants and drive growth. 3 Te Kehu Way was completed on budget and with projected yields ahead of target, a great outcome given cost price pressure throughout the whole period. We're currently finalizing the lease up of the building, but I'm pleased to welcome new tenants, such as Geneva Finance, CLC Engineering and the government agency, Rau Paenga to the list previously announced. On to Slide 10. 3 Te Kehu Way is just one place we've made major progress on our targeted development program in FY '23. Construction of New Zealand's first major build-to-rent development is now also well advanced at Sylvia Park. Once completed, the project will bring residential to the precinct for the first time, marking a key milestone in its transformation into a world-class mixed-use community. Construction of the 295 apartment BTR complex is now up to 9 levels high and apartment fit-outs are underway. The government recently passed tax legislation establishing BTR as a recognized asset class in New Zealand, creating the foundation for its expansion. As you can see from these graphs, Auckland residential rental growth has largely outpaced CPI for the past 20 years. As such, build-to-rent offers a potential hedge against inflation, a defensive characteristic that's highly relevant in the current market. New Zealand experienced a net gain of 52,000 people in the year to February 2023. That's the equivalent of a 1% boost through our population requiring around 19,000 extra houses. Despite the surge and immigration, residential construction has declined rapidly with the number of new building consents down 18% in the 3 months to February compared to a year earlier. We expect this divergence between demand and supply to place upward pressure on rents and drive and increase in demand for quality rental accommodation such as that being offered at Sylvia Park build-to-rent from Q1 FY '25. Our 125-hectare strategic landholding allows us to dictate the timing of activity and be selective about new opportunities. A great example is the sale of the 3.2 hectare site at Sylvia Park to IKEA, which is now unconditional. While we are pleased with our progress on these projects, we will be extremely disciplined about moving forward with any additional development in the current market. Decisions of when, where and how to proceed with new initiatives will be dictated by demand, funding, the cost of capital and the ability to create value for shareholders. Turning now to Slide 11. Strict capital management is a priority for Kiwi Property with capital recycling being an important pillar to our strategy. Asset sales provide a comparatively low cost of capital and now enables us to create a newer, higher quality and lower risk property portfolio. We delivered strongly on this front over the past year, successfully disposing of Northlands and 44 The Terrace in December and post balance date completed the sale of Westgate Lifestyle Shopping Center for NZD 85.7 million, with settlement having occurred on the 1st of May. Following this latest transaction, gearing now sits at 33.3% on a pro forma basis. We're focused on maintaining our debt levels within an acceptable range and mitigating interest rate cost increases through proactive hedging. In addition, we will strictly manage costs and drive efficiencies within our business with a view of optimizing performance and overheads. Please turn to Slide 12. We've been committed to sustainability for 20 years and have made substantial ground towards our goal of becoming net carbon negative in our operations by 2030. Over the past couple of years, ESG has taken a step forward in terms of its importance to many of our current and potential investors. This is a positive development and one we're highly supportive of. Our efforts in this space are guided by our comprehensive sustainability strategy, which is based on the pillars of places, people and partnerships, as shown on the slide, each with their own set of KPIs. We achieved a number of important ESG milestones over the past year, which contributed to us being awarded a score 81 out of 100 by the Global Real Estate Sustainability Benchmark. Sustainability is an important consideration in our development program and by being mindful of environmental standards at the outset of a project, we're better able to avoid future costs due to changing environmental standards. As you can see here, many of the company's existing and future buildings enjoy excellent sustainability credentials, including ANZ Raranga, which achieved a 5.5 star NABERSNZ ratings this year, up from 5 stars in 2022 due to the continued improvements in operational efficiency. The Sylvia Park build-to-rent development has already been awarded an 8 Homestar Design rating and we're awaiting sign off of the NABERSNZ rating for the newly completed 3 Te Kehu Way building, where we are targeting 6 stars. Working closely with Naylor Love, our construction partner and waste management NZ. we've managed to divert more than 92% of the construction waste from these projects away from landfill highlighting our commitment to sustainable development. Let's look at FY '23 results now beginning on Slide 14. Kiwi Property posted another strong operational results in FY '23, delivering growth in key metrics such as sales, rental income, operating profit and adjusted funds from operations. Net rental income rose to NZD 203.7 million, up 13.9% on the same time last year. While this figure benefited from the release of COVID-19 rental abatements that were not required, the key driver was the strong performance of our assets led by Sylvia Park and the Base. The company's ability to grow rental income while disposing of assets was particularly positive with net rental income increasing NZD 16.5 million or 10% in FY '23 after adjusting for asset sales. Operating profit after tax was also up, increasing 11.3% to NZD 129.6 million, reflecting the pleasing performance of our diversified asset portfolio. In parallel, AFFO rose 16.1% to NZD 116.5 million, underpinned by the higher operating profit through the financial year. The company's robust operating 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 10% or NZD 352.6 million, leading the business to post a net loss after tax of NZD 227.7 million. While the decrease in fair value -- in the 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 will be in the strongest position to mitigate potential future devaluations. Please turn to Slide 15. As I've already mentioned, the company delivered NZD 1.72 billion in sales in FY '23, up an impressive 28.5% on the year before across our mixed-use and large format retail centers combined. Growth was broad-based, although the performance of the specialty and commercial categories as well as many majors was particularly strong. Specialty sales rose 30% to NZD 12,700 per square meter, while specialty gross occupancy costs were 12.9%. These numbers highlight the productive nature of our retail tenancies as well as the headroom to grow rents. We believe that as our sites become increasingly mixed use, we will be in an even stronger position to attract more customers who will stay at our site for longer and spend more money than they do. Please turn to Slide 16. The company drove total rental growth of 5.2% in FY '23, up from 4.2% the year before. New leasing was up 4.4% across our office and mixed-use portfolio while rent reviews rose 5.3%. Portfolio occupancy remains high at 99.3%, while the weighted average lease expiry across our portfolio sits at 4.4 years, marginally down from last year. Please turn to Slide 17. Maintaining our robust and flexible balance sheet is a focus for the business, especially in the current market. The previously mentioned reduction in the fair value of our property portfolio saw our gearing increase to 35% as of 31 March 2023. However, this decreased to 33.3% on a pro forma basis following the sale of Westgate Lifestyle. Net asset backing per share was similarly affected decreasing to NZD 1.23 per share. Now to Slide 18. We undertook several capital management activities in FY '23, including extending our bank debt facilities from NZD 850 million to NZD 1 billion. In addition, we executed a successful NZD 125 million green bond raise during what turned out to be a week of extreme volatility in the debt capital markets following the collapse of Silicon Valley Bank. The raise generated particularly strong uptake from retail investors nationwide highlighting the breadth of support for Kiwi Property, our business strategy and our sustainability credentials. These 2 initiatives enabled the company to increase its weighted average term of all debt facilities to 3.8 years. Kiwi Property's weighted average cost of debt grew from 3.85% to 5.18% driven by the rise in interest rates that have been a recent feature of the international and domestic economies. At 31 March 2023, our debt book was 90% hedged on a pro forma basis following the sale of Westgate Lifestyle. This cover will offer a high degree of protection against further interest cost increases. Turning now to Page 19. Kiwi Property will pay a quarterly cash dividend of NZD 1.425 per share for the fourth quarter and FY '23, taking the full year cash dividends to NZD 5.70 per share. We are committed to maintaining and then growing the dividend over time and the fact we've been able to do this in a period of economic volatility while also selling assets speaks to our intent. Kiwi Property will reinstate its dividend reinvestment plan for the fourth quarter FY '23 dividend, pricing will be based on the volume-weighted average price of KPG shares for the 5 days to the 12th of June and will be subject to a 2% discount. The DRP contributes to our multi-faceted capital management program and will support shareholders to grow the Kiwi Property holdings free of transaction costs. I'm also pleased to confirm our full year cash dividend guidance of NZD 5.70 per share for FY '24, which we expect to be within our target payout range of 90% to 100% of AFFO. As always, dividend guidance and payments are contingent on the performance of the company and barring material adverse or fixed or unforeseen circumstances. I'm now to Slide 20. As you have seen, Kiwi Property delivered a robust operating results in FY '23 and took important steps forward in the delivery of our strategy. Heading into the new financial year, we have 4 specific priorities. First, we'll drive proactive capital management, mitigate interest cost increases and maintain balance sheet flexibility. Second, we will continue driving operational excellence across our high-quality asset portfolio with a focus on cost control, growing rents and driving sales. Third, we will prepare for the launch of Sylvia Park BTR 1, including successfully launching the Resido brand to the market and establishing our build-to-rent operating platform; and fourth, we will position Kiwi Property for the future by completing Drury Stage 1 earthworks concluding our Yardi ERP implementation and identifying opportunities that will enable Kiwi Property to drive revenue and returns for our shareholders. We're extremely conscious of the current period of economic volatility, and we will adopt a highly disciplined approach to the operation of our business in FY '24, delivering on strategy, driving our asset performance, strictly managing our balance sheet and being pragmatic in the timing of our development program. Importantly, our commitment to delivery remains as strong as ever, if not more so. Our goal is to perform today while simultaneously transforming Kiwi Property into a more resilient and ultimately, more profitable business for the years ahead. Before I conclude, I'd like to make a quick mention of Mark Ford, who will be standing down as Kiwi Property's Chair at the upcoming annual meeting and will be replaced by existing Director, Simon Shakesheff. Mark has made an enormous impact to the company over more than a decade, and I'd like to thank him for all his support. Mark Powell has also recently stood down from the Board and will greatly miss his commercial insight. We're very lucky to have 2 excellent new directors joining the Kiwi Property Board, Carlie Eve and Peter Alexander. I'm sure they're going to add a huge amount of value to the company and our shareholders. Thank you all for joining the call today. That concludes my overview of our annual financial results. I'll now hand over to the moderator, who will open the phone line for questions.

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

First question just a few on build-to-rent. All the adjoining properties, I think there's NZD 265 million in the balance sheet. So that -- how much of that is build-to-rent work in progress?

It's Clive. And firstly, thank you to Steve for being the read of the announcement to me. Could you just repeat that question?

I just want to sort of get a sense of how much of -- what the work in progress value or cost of build-to-rent at this point? And then I guess sort of related to that, I see there's NZD 114 million of commitments at Sylvia Park. So just trying to sort of see where you sit on total cost versus, I think, the NZD 220 million you were initially targeting.

Yes. Maybe I'll answer that at a high level, and Steve might have some additional detail that we can give you on that. So we saw remaining within our metrics of 4.5% for yield and targeting an [ ARR ] of over 8%. We are facing some cost pressure, but we're managing through that successfully at the moment with Naylor Love, our head contractor. And also on the other side, we're also starting to see some favorable increases in rent coming through in the market as well, which is giving us confidence around rent increases above where we had originally set them. So that gives us some confidence. Steve, have you got the detail that Arie was looking for?

The What's not broken down in the valuation that's sitting within the Sylvia Park Precinct. As you'll see in the valuation note is approximately NZD 153 million of spends on Sylvia Park Precinct to complete it.

Okay. Yes. No. I mean I just understood that the adjoining properties, which I think sits at NZD 265 million for Sylvia Park. I thought that includes Sylvia Park build-to-rent. And so I was just wondering how much of the NZD 264 million related to build-to-rent.

Yes, sure. I can check it for you. Adjoining land around there as well other. Yes.

No, that's fine. And Clive, just quickly, just on that stabilized yield, your Q1 '25 completion, what sort of time frame are you allowing for to achieve -- to reach that 4.5% stabilized yield?

Yes. The lease-up period is around 12 to 18 months. That's a standard lease up for a build-to-rent development of this size. And obviously, that will be dependent on the market forces at that time. I think from my perspective, I think our timing is actually working out really well. Immigrations, as we called out, has been turned back on, and we're seeing a strong number of immigrants coming back into the country, student accommodation is in short supply. And to a certain extent, the supply side of the market has been turned off given the high interest rates, which have obviously discouraging new residential development. So if we look to the Australian market at the moment, they're seeing some very high rents coming through in the major CBD areas such as Melbourne, Brisbane and Sydney. And a lot of that is driven through those same factors that we are facing here.

Great. And then last one on build-to-rent is just the operating platform. I guess just a couple of things. Firstly, what do you sort of -- now as you're getting closer, obviously, including on the platform and then gearing up to sort of launch, what do you sort of see the overhead costs associated with running build-to-rent being? And what's your assessment of sort of the market sizing for potential third party income off that platform?

Yes. So the sort of indicator that you see internationally, and we're obviously looking out at international sort of precedents to help us in this space is sort of in that Sort of 23% to 30% is the operating cost that you see coming through. So we sort of are pitching ourselves in the middle of that market sort of data at the moment, yes. And obviously, we're building a platform that we hope to be able to leverage in the future. We first have to prove up our first build-to-rent. But once we successfully have done that, we'll look to either offer our services to third-party and a build-to-rent developments ourselves. So we're giving ourselves that flexibility to do either.

Right. Just turning to LynnMall on the Base, just interested in a couple of comments from you. I mean it doesn't appear like the valuers are giving you a lot of credit for mixed use there on cap rates over 7%. Is that sort of your perception? And then I guess sort of related to that, time frames for mixed use and probably LynnMall in particular, like when market conditions normalize, are you still working towards build-to-rent LynnMall? And can you just sort of give an update of your progress there even with regards to design and consenting in that?

Yes. So as you recall previously on LynnMall, we had a build-to-rent scheme that we had received resource consent for. So we do have that in our pocket. And when -- obviously, when we believe the market has turned and we have proved our build-to-rent Sylvia Park and that will give us an opportunity to reassess proceeding with LynnMall. In terms of valuations for LynnMall at the Base, in particular, at the Base, it's a really, really strong center. And you can see sales are now exceeding NZD 500 million, which is fantastic. We're seeing great rental growth and demand coming through from tenants in that space. And we've started to see other uses other than pure retail coming into play there. We're starting to see some office and medical tenants are looking for space. So we think it has all the attributes of mix -- creating a mixed-use community, just a little bit further down the journey to go. So we hope that as we're able to prove that up, valuers will obviously take it on board when they look at their valuations, yes.

And then last one for me, just Drury. I guess just timing and approach, I guess, just on that spend that you've sort of outlined to complete Stage 1. And I guess on the residential, in particular, would you be looking for committed contracts before you committed to spending a large portion of that NZD 94 million? What's going to be the approach there? I see there's only NZD 6 million of commitments at year-end for Drury?

Yes. So that NZD 6 million is the existing earth-moving contract that we have. We obviously still have to put the civils into the development as well, but we've also called out and we've been quite open about this that we will look to sell down the super-lots and potentially some of the large format retail sites as well. And we will start to look for joint venture partners to join us on this journey. And so we believe that, that will give us the mechanisms to be able to fund the development as we go forward. So we'll do it on a stage basis. So as we start to make progress on some of those areas, we'll be obviously releasing capital for further development work as we go forward here.

Yes. Okay. So we shouldn't expect a material investment at Drury in FY '24.

Not the full NZD 94 million though. That's more over a period of time that they will be spent, yes. That's just to indicate what that will look like over a period of time, yes and give some guidance.

In these market conditions, do you think you could get yourself in a position where you might be spending NZD 25 million to NZD 50 million at Drury this year?

Potentially, yes. But again, it's balanced upon what those transactions could look like on the other side, yes. And we do have some interest in transactions, yes.

Our next comes from the line of Bianca Fledderus with UBS.

So firstly, I may have missed it, but could you share what the cap rate was on the Westgate asset sales?

Yes, sure. Steve, have you got that cap rate at hand?

Yes, I'll get that. It was 5.7%.

Okay and then just on Sylvia Park, of course, that did really well last year. Could you just comment a bit on what you're seeing just in the retail space at the moment? Is it still strong in the first month of trading of FY '24? Or are you starting to see a greater number of struggling tenants?

Yes, yes. Thanks, Bianca. You heard me talk about the bifurcation of retail before. And this is really evidence of the performance we're seeing in some of these key mixed-use centers. Sylvia Park and the Base and LynnMall to a certain extent, are attracting high-quality tenants, and we've got great demand in all these centers, which is really driving the mix which ultimately drives the sales performance and allows us to increase our rental for the back of it. We aren't seeing any significant signs of tenant stress in any of our key centers, which is, again, it's about that performance that we're seeing in these high-performance flagship centers. So at the moment, all the signs are positive. We're seeing growing customer numbers, growing sales and growing demand at us in our key centers.

The cap rate, sorry, for the passing year, it was 7.1%. Apologies.

Yes, just last one quickly, could you share what your expectation is for your effective tax rates for FY '24 please?

I'll pass that one over to Steve. That's definitely a financial question.

Yes. So I think our effective tax rate was about 13% for this year. I'll have to get back to you on the details of that. That's the forecast number as well.

Your next question comes from the line of Nicholas Hill with Craig Investment Partners.

Congratulations on the results. Just sort of looking at inflation in the top line, you reported property income of NZD 256 million, of which NZD 400 million like -- NZD 43 million was property expenses recovered from tenants, so back of the envelope, around half of your property costs are passed through to tenants with you absorbing the rest. That increased about 5% on FY '22 levels. Could you give us some color as to how these cost recoveries are structured and how their escalation has passed on?

Yes, good question. So effectively, obviously, our portfolio is made up of a number of different areas. So there's obviously the retail component, which is reasonably significant this offers. And we also have some sundry properties around industrial as well. If I talk firstly to the retail component, effectively, what we do is -- on average, what we look at is -- we look at all the costs that we have across the year. And depending on the lease structure with each of those tenants, we then allocate the recovery of those costs back to the tenants that probably -- and we obviously budget for what inflation can be in there. If there's a true-up at the end of the year in terms of any of those costs, which may have risen as high as a result of inflation, then we obviously back charge those to the tenants within the pre-agreed sort of metrics within their leases. And that's not dissimilar to what we have in the office space and the other parts of our business as well. So sorry, a little bit of a convoluted answer. I hope that answers your question.

That's good. Just sort of thinking about the retail part. You've got these like very large tenants, flagship stores and everything. Overseas experience tends to indicate that they have quite a bit of negotiating power, and they don't really like or tend not to sort of pay these cost recovery terms. How do you think about sort of incorporating like the mix of sort of like big tenants versus small ones and the cost recovery allocation there?

Yes. Look, there's a little bit of nuance to that. There is some differences around the size of the tenant and the recovery, but on the whole, the vast majority of our tenants do participate in a recovery of cost here and that's well accepted. Some of our peers, especially internationally use a semi gross lease approach, we don't have a semi gross lease. So we pass those costs back on the way other landlords have to deal with those costs in-house, yes.

Okay. So I was thinking high inflation, coupled with deteriorating macro picture, so your top line rental growth may be as an example, a bit muted, but so the cost recovery terms in place, inflation and direct property costs will also be slightly muted.