Precinct Properties NZ Ltd & Precinct Properties Investments Ltd (PCT) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Precinct Properties 2022 Full Year Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Scott Pritchard, Chief Executive Officer. Please go ahead.

Thanks, Ashley, and good morning, everyone, and welcome to the 2022 annual results briefing for Precinct Properties. I'm joined today by George Crawford, Precinct's Deputy CEO; and Richard Hilder, Precinct's Chief Financial Officer. Like previous years, the 2022 financial year has presented many challenges with considerable amounts of time and lock down, especially for the Auckland based team and the Auckland assets. This has lead to considerable uncertainty with regards to city centers, office space workers and the lack of international visitors. Despite these challenges, we are very proud of the performance of the business, the performance of the people and the decisions made during the year to support those occupiers within the business who we believe needed support in order to survive over the last couple of years. The program for today's call is outlined on Page 2 of the presentation. I'll shortly provide an overview of the highlights of the result before touching on some major themes and reviewing Precinct's progress relative to our strategy. I'll then hand over to Richard, who will cover off the financial result before George provides an overview of our markets, our operational performance and our development activities. Following that, I'll provide some concluding comments, and as usual, we will be delighted to answer any questions that you have at the conclusion of the call. Moving to the highlights page. We are delighted with our progress this year to establish a partnership with GIC, the Singaporean sovereign wealth fund. As announced today, Defence House may not be included as 1 of the seed assets, and we're currently in discussions regarding alternative opportunities. We continue to anticipate growing this partnership to around $1 billion in total value. Pleasingly, our operating income has grown significantly in the period reflecting the savings from internalization and demonstrating resilience in our property incomes. We have also recorded a pleasing comprehensive profit of $108.8 million, following a modest revaluation gain of $19 million for the year. Perhaps most pleasing is the strength in our AFFO, despite providing significant support to retailers at Commercial Bay, which Rich will touch on a little later. Our annual dividend of $0.067 per share demonstrates a 3.1% increase over the prior period and reflects a 103% payout ratio after the extent of rental support provided. Our development activities remain highly active with the completion of wearing Famous Street in Wellington, and significant advancement of Bowen Campus Stage 2 and Wellington. The Deloitte Center continues to progress well, and we commenced work for Wynyard Quarter Stage 3 and are currently advancing discussions on a range of development opportunities currently. Also pleasing is our operating performance, where occupancy has been maintained at 99%, and our rental growth recorded on new leasing has demonstrated the strength of the office market. We have completed significant 34,000 square meters of leasing during the last 12 months, which is consistent with a record year last year and is materially above our annual average, which further demonstrates the interest that businesses have in occupying high-quality of space. Turning to Page 4 and our strategy. As outlined in February, following the decision to internalize our strategy has been refined to now include the ability to partner with direct investors offering the opportunity for joint investment into our assets and into development opportunities. This has been advanced during the year with the establishment of our partnership with GIC, and we expect to progress this partnership in the next 12 months. We've also been very focused on our people with a constrained labor market and a lack of talent given the elevated levels of activity, we have taken a proactive approach to ensure our Precinct and our Generator teams are fully engaged with the business. In terms of operational performance, we are delighted with the positive revision being achieved on our leasing activities, with 13.5% average uplift on new leasing achieved in the last 12 months. We've also committed to a sustainable debt program and committed a few weeks ago to the World Green Building Council Net Zero Carbon initiative by 2030. We've also advanced our development activities with the completion of Wearing Taylor Street in the period and the commitment to start Wynyard Quarter Stage 3 during the year. We're excited about the opportunities in the market and are currently considering further opportunities to add value for our shareholders and for our capital partners. Page 6 sets out a summary of the key themes which we are observing in our markets. Undoubtedly, for us, the opportunity to partner with direct investors is exciting, and it allows Precinct the opportunity to participate in a wider set of opportunities. We expect to advance our partnership with GIC, and we'll also look to grow our partnership base during the next 12 months. The rising interest rate environment has rated question marks around valuations and the potential for valuations to come under pressure due to these higher rates. This remains a potential outcome, and our view is that cap rates will soften moderately due to these higher rates. However, the valuation impact will be mitigated by rising rental rates, which we have seen in the market. Our strong view is that the higher quality end of the real estate market will be considerably better during this cycle. The occupier market for prime space continues to perform incredibly well, with strong regional growth and growing demand. We are seeing significant demand for our assets, particularly those located on the waterfront in Auckland or in seismically strong buildings in Wellington. It is clear that businesses are prioritizing their staff and seeking higher quality spaces to attract staff back to the office. This is working in our favor. The construction market remains under significant pressure with supply chain issues and labor shortages. Escalation and costs have continued during this year with indicative pricing 5% to 10% higher than this time last year. We anticipate that the residential construction market to further weaken, which may provide some additional labor for the commercial construction market. We have seen some signs of supply chain issues easing, although this easing, we expect will take some time to materialize. The city center has continued to be impacted by lockdowns and more mentally by the rise in crime and anti-social behavior in the cities. Workers are returning to the office, which is pleasing and they are supporting city center retailers. However, the public yet to return in a meaningful way due to concerns around safety. The first cruise ship that arrived last week in Auckland signals a further tailwind for the city centers, with over 100 cruise ships due to arrive in Auckland from October this year. Commercial Bay retail has had a challenging 12 months. However, we remain very confident that over time, it will perform well. And last week's cruise ship passengers gave us a glimpse of how well this asset will meet the needs of international visitors. I'd now like to hand over to Rich to take you through the financial results.

Thank you, and good morning, everyone. Total comprehensive income after tax for the period was $108.8 million. This was down on the comparable period due to last year's revaluation gain. Operating income before income tax rose 14.8% to $95.3 million. A key contributor to this was the material reduction in management expenses following last year's internalization. The overall savings compared to FY '21, including capitalized costs, was $10 million. The revaluation movement for the period was $19 million, driven mainly by development profit recognition. As at 30 June, the portfolio value totaled $3.7 billion with present NTA per share at balance date increasing to $1.54. Turning to the next slide. Our business has continued to be impacted by COVID and the prolonged lockdowns that occurred during the last first half of the financial year. Pleasingly, Precinct's core office portfolio has delivered strong results. Net property income increased marginally to $126 million. However, this included around $8.3 million of COVID support. Most of the support was provided to retailers and hospice venues were only a small amount of office-related contractual abatements. After adjusting for the support, normalized property income was 7% higher which was largely due to improved occupancy at better. Precinct operating businesses have also been impacted by continued disruptions. While generators membership occupancy and revenues have remained strong, the events business was heavily impacted. This contributed to an operating loss of $700,000 Commercial Bay hospitality recorded a loss for the period of $1 million due to closures, lockdowns in staffing constraints. Pleasingly, however, the operating performance for both businesses improved in the last quarter of the financial year. Turning to the next slide. Funds from operations for the period was $0.689 per share, while adjusted funds from operations or AFFO, which measures our dividend paying capacity was $0.651 per share. This was a strong result given the financial impact of COVID on the business. Normalizing for the support AFFO would have been around $0.069 per share. The FY '22 dividend of $0.067 per share was 3.1% higher than the previous year and reflected an AFFO payout ratio of 103%. The following slide provides an overview of our tax expense. Precent recorded a positive tax position for the financial year of $7 million. The positive position is due to contaminant development signature and the disposal of depreciable edits primarily relating to One Queen Street. Tax expense for the next year is expected to remain low, mainly due to deductible CapEx and disposal of depreciable assets at 1 Willis. Moving to capital management. During the period, we listed to convert the convertible note to equity, secured a new $300 million bank debt facility and issued $175 million green bond. These initiatives take total committed funding to $1.6 billion. with the weighted average term to expiry of 4 years. As at June, gearing was 34%, well below our banking covenant of 50%. Proceeds from the investment partnership will initially be used to repay back debt and will reduce pro forma gearing. As noted by Scott, we continue to explore further third-party capital initiatives. As a result of the strategy, it is anticipated that funding requirements will move off balance sheet through either passive or more active platforms. Consistent to the changing interest rate environment, our weighted average interest rate has increased to 4% as at 30 June. Committed development cash flows have been partially hedged by forward swap agreements with average hedging over the next 3 years of around 50%. Average hedging for FY '23 will be around 65%, assuming the sale of Defense House does not proceed. Turning to ESG. We have made considerable progress in the period demonstrated by the establishment of the Board ESG Committee, another strong score and most recently, present commitment to Net Zero Carbon. This commitment is to minimize total emissions, both operational and embodied over an embedded life cycle. Precinct has a several years offset emissions relating to construction. However, this commitment goes through that, and we'll seize business focus on more sustainable design and products to minimize upfront emissions. A recent example of this is the flower building in Wynyard. This building utilizes cross eliminated timber for its structure, resulting in whole life cycle emissions being around 35% lower than a traditional development. This commitment has also seen Precinct lift its ESG targets. We are now targeting that the energy efficiency performance of our portfolio meets a minimum 4-star mandating, meaning an excellence level by 2030. This commitment should see us reducing our operating emissions by around 50%. Finally, turning to dividend guidance. We've announced today in FY '23 dividend of no less than $0.067 per share. Despite rising interest rates, we have a well-positioned portfolio and a strategy that gives us confidence in our mining outlook, an improving operating environment, growth in third-party capital and attractive development returns should all underpin earnings accretion. Thank you. I will now hand over to George.

Thanks, Richard, and good morning, all. Turning to Section 2, our markets. In summary, the occupier markets are in strong shape, and the city center retail market had the best forward outlook that it had for the last 2 years. Across both Auckland and Wellington, office leasing demand for the right buildings and locations has continued to be strong with occupiers being increasingly decisive as the future work site may become more certain. This trend is benefiting both the traditional leasing and flexible space sectors. There's no doubt that the uncertainties of lockdowns over the last 2 years have taken their toll on retailers, and this is not compounded by the staffing crisis. We are proud of the support we provided to retailers over this period, and we believe this positions us well to benefit from an improving city center retail environment. The return of overseas visitors has been eagerly awaited by our retailers, and there was a real sense of excitement in Commercial Bay with the arrival of the first crew ship last week. The recovery path will continue to have challenges, but we're very pleased to be looking forward. Looking more closely at the Auckland office market on Page 17. The 2-tier market we've been calling out for the last 18 months is persisting. This is seen most clearly in the chart on the bottom left-hand side, with next to no vacancy on the waterfront, while the rest of the CDP is seeing increasing vacancy levels. On Page 18, the Wellington occupier market continues to be very strong across the board, with very low levels of vacancy, particularly in the government precinct. Turning to the investment market. The last 6 months have seen a high level of volatility as interest rates increased significantly before settling at more moderate albeit higher levels. In our view, the office investment market has reacted in quite a balanced way with higher interest rates, offset by recognition of the positives around more certain occupier demand and risks from working from home diminishing as well as signed evidence for market rental growth. As set out on Page 19, this is reflected in our portfolio revaluations, which recorded an overall gain of $19.3 million despite cap rates softening by on average 10 basis points. At this point, we don't see the signs of financial distress that would be required to drive values materially lower. Turning to Section 3. It's pleasing to report that the strength in the occupier is translating to strong rental growth and both portfolio and development leasing for ourselves. Across the 11,000 square meters of new portfolio leases completed in the period, we've seen a 13.5% increase compared to the previous contract rent. This equates to a CAGR of around 5%. Moving to Page 22. Overall, our portfolio metrics remain in very good shape with a manageable lease expiry profile, a weighted average lease term of 7.1 years and occupancy of 99%. Across the next 12 months, we have around 12% of the portfolio up for market rent review as well as 5% expiring. With our portfolio now 6.3% under-rented, this provides opportunity to secure further growth in our rentals. Moving through to Section 4. It's pleasing to report on a healthy and high-quality development portfolio with 6 projects underway and at varying stages of completion and leasing. Our portfolio currently totals $1 billion in value and is forecast to deliver around 20% return on cost on completion. As outlined on Page 25, it has been a busy year with the completion of redevelopments and successful reopening -- and successful opening of Generator Wellington at 30 Waring Taylor Street. Strong leasing success at One Queen Street, and 40 Bowen and the commencement of construction at Wynyard Stage 3. Moving to Page 26. At Bowen Campus, we're looking forward to the completion of 40 Bowen in around 2 months' time. 44 Bowen also continues to progress well with the site installation well underway. These projects were committed to in 2020 in what were uncertain times, and it's pleasing to see them nearing completion with very strong financial metrics to deliver a 6.6% year on cost and almost fully leased. On Page 27. One Point Street to be known as the Deloitte Centre also continues to progress well. The site installation to the hotel levels is now giving a sense of the impact that the completed building will have on the Auckland Waterfront. The reopening of international hotel markets is also encouraging for the performance of this asset on completion. On Page 28, the focus for the third stage of Wynyard has been on launching the leasing opportunity to the market. It has been very well received with a high level of interest in securing premium grade accommodation in this location, and we are in negotiations with potential occupiers. Finally, while our current pipeline of projects is progressing well, we are keen to take advantage of the strength in occupier markets to secure future projects. We're conscious of the rising interest rate environment and construction cost escalation, and the need to ensure that returns are appropriate and we'll endure it through the cycle. In this environment, however, we believe that there are good development opportunities to be found. Thank you, and I'll hand back to Scott.

Thanks, George, and turning to the final slide. There remains little doubt that the economy is facing some headwinds with rising interest rates and a constrained labor market. Despite widespread demand for goods and services, the labor market is acting as a significant inhibitor for economic growth. This uncertainty is evident globally, and this record rise in inflation is leading to material increases in interest rates. In this environment, real estate valuations can come under pressure from softening cap rates. Despite this, we continue to see very strong demand for high-quality assets and very strong rental growth. It is our view that the extensive impact from softening cap rates will be determined by the ability to attract rental growth. Precinct is well placed in this regard with growing demand, strong rental growth and an increasing set of transaction and development opportunities to add value during the cycle. While the uncertainty and volatility won't be concerning to some we remain very optimistic about the position of Precinct and the opportunities that this market will present. Finally, as Richard outlined, we have guided today to an FY '23 dividend of no less than $0.067 per share. This reflects the impact that rising interest rates has on our AFFO that gives us confidence that over the long term, we can continue to grow our AFFO and our dividends for our shareholders. Thanks, everyone. Really appreciate your support and very happy to take any questions that you might have.

[Operator Instructions] Your first question comes from Arie Dekker with Jarden.

Yes. First question is just sort of looking to FY '23 and the normalization of out of some various COVID impacts. I guess, across the support, you've called out $8 million in FY '22. And then I guess also to generate hospitality where you said you're seeing more encouraging signs in fourth quarter. So I guess just specifically, presumably no contractual abatements are sort of ongoing into FY '23. What sort of level of support are you currently still carrying through?

Scott here. We're not carrying any further support in terms of the provision of abatements or rental release from here.

Okay. Great. So where do we sit today and for what we sort of know in terms of hopefully no more lockdowns and that sort of thing, we should expect that $8 million to completely reverse out?

Yes, that's right.

And then on Generator, I mean, as an EBITDA profit sort of in the low single-digit millions, what you're looking for in FY '23 and somewhere around breakeven for hospitality. Is that sort of a reasonable expectation?

Yes. I mean, we'd like to think that's an expectation and kind of early signs giving us confidence around that.

Great. Just moving to GIC. Can you just sort of talk to the timing of any other assets into that fund? I mean, is that something that defense house doesn't go through or even if it did, that we could sort of expect in the first half of '23. And then just sort of secondary to that, are there any other capital partnerships being looked at currently for existing assets?

Yes. Arie, it's George here. Yes. So in terms of when we would expect settlement to occur on the assets which are waiting OIO consent. We'd expect that to be in the first half of FY '23. And in terms of further opportunities with GIC or with other parties, the investment environment has obviously been changing higher interest rates. And that has an impact on return requirements. . But they sort of offset to that with what we're seeing in terms of occupier demand, that's seeing offshore parties, in particular being quite positive on Auckland and Wellington within that sort of broader context. So there's a range of ways that as we said it before that we could work with other parties, it could be around development opportunities as well as in our stable portfolio, and we continue to have those conversations.

Yes. Okay. Yes. I mean at this point, clearly, you couldn't sort of fact if something can sort of in terms of announcing the next sort of development in this area sort of necessarily in the first half of this year?

Look, it could potentially be in this period. It could potentially be beyond us. There's -- across our development opportunities. There are various things that we're working on, and that could come through in the first half or it could be later.

Sure. And then just a final quick one. Just on the uncommitted opportunities. I mean from the commentary, it looks like you're suggesting there's a reasonable, well, quite a high likelihood of committing to 117 Pakenham. Is that fair?

Yes. I mean, look, we're really encouraged by the amount of inquiry for Wynyard quarter. And -- there's no doubt that businesses have identified that location, the last waterfront site in the city, large [indiscernible] definitely surprised us to the upside in terms of the amount of inquiry that that's attracted. All things going well, we'd like to think in the first half of this financial period that we can get some get some leasing done, and we -- that might lead to us committing to 117 Pakenham. So we're testing the market at the moment around pricing, and we're advancing negotiations in terms of potential leasing. So we're encouraged by how that opportunity is playing out at the moment.

Your next question comes from Nick Mar with Macquarie.

Just on the dividend outlook, could you just sort of talk to factors that would see it different sort of $0.067, which you said is the sort of minimum?

Yes, Nick. Look there's a range of things, I guess. I mean, as you know, there's been a huge amount of volatility in rates just in the last 2 months, let alone in the last 6 months. So certainly, interest rates is a pretty big factor. We're also seeing some early signs of some positive performance out of Generator in the hospitality business, which is encouraging, and that could drive some support. . Commercial-based retail, where we've provided a lot of support, but we still have a fair amount of exposure to turnover provisions within leases and so on. That's going to be a key determinant of our AFFO performance, and therefore, our dividend in the next 12 months. So there's sort of a number of factors within there that have led us to sort of turn our guidance where it is at the moment.

And there's the intention that it's back to being around the 100% mark. Again, obviously, it was slightly over for FY '22. And you didn't obviously want to turn the [ debi ] back. Is that sort of a fair assumption for how you're looking at '23?