Property For Industry Limited (PFI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the PFI Interim Results Presentation. [Operator Instructions] I'd now like to hand the conference over to your first speaker today, CEO, Simon Woodhams. Thank you. Please go ahead.

Good morning, and welcome to Property For Industry's interim results announcement for the 6 months to June 30, 2020. As Tara said, it's Simon speaking, I'm the CEO of PFI. And alongside me today is Craig Peirce, our Chief Finance and Operating Officer. [Operator Instructions] All right. This morning, Craig and I will speak to the topics outlined in the agenda on Page 2 of the presentation. I'll begin by reviewing the highlights for the period and give an update on COVID-19, followed by an overview of the portfolio and its key metrics as at June 30, Craig is then going to give you an ESG update and take you through the interim results before presenting sections on capital management in the market. After which, I'll give you an update on our priorities and close the presentation. There'll be an opportunity for questions at the end, should you have any. So if you turn now to Page 4 of the presentation, it's the highlights. In what can only be described as a turbulent start to the year, we're pleased to report on what we consider to be a very resilient interim result. Of note, that Craig and I will speak to further throughout the presentation is the strength of our balance sheet with our NTA unchanged and additional banking facilities secured during the period. Our portfolio metrics, including our occupancy remaining at 99%, and our weighted average lease term or WALT at 5.28 years being maintained. And our second quarter dividend is to be paid, along with the reinstatement of our dividend guidance, where we expect to pay a total cash dividend for the 2020 year of $0.0765 to $0.0707 per share. I now turn to Slide 6. As you would expect when COVID-19 started to unfold, the health and safety of our team and our tenants was our first and top priority. The management team was able to very quickly establish themselves in a working from home mode, which allowed us to then switch our focus to taking a series of steps to ensure the company was in a position of strength to deal with what was coming. Those steps included: providing support to our tenants, especially focusing on some of our smaller and most vulnerable tenants; securing additional liquidity from one of our banking partners; examining both our capital and operating costs; and where appropriate, making cuts or deferrals; and we also utilized the dividend reinvestment scheme as a further source of capital. Pleasingly, our performance over the first 6 months is materially in line with the prior interim period in the second half of 2019. The mix effect has contributed to this, including the reintroduction of depreciation on building structure, which Craig will discuss shortly. But we also note that PFI has continued to experience high levels of REIT collection in excess of 95% through July and August. Moving on to Slide 7. The onset of COVID-19 has reaffirmed to us that our strategy of moving to a pure-play industrial property vehicle is the right one. As a management team, we've always focused on keeping gearing at manageable levels along with only paying out cash covered dividends. This has left us very well placed to deal with the latest challenges and take advantage of any opportunities that may arise from the current environment. Looking forward, we acknowledge that COVID will affect large changes to society. Key themes we anticipate in it for PFI is the acceleration of e-commerce and businesses looking to create localized and resilient supply chains, which will in turn drive demand for industrial space. Let's turn to the slide headed Portfolio Snapshot, #9. Here we have a summary of the portfolio statistics. You can see that the company continues to own a well-diversified portfolio of 93 properties leased to 140 tenants. Over the last 6 months, despite the market uncertainty, the value of the portfolio has remained stable at $1.47 billion. Our occupancy is tracking well at 99% and our WALT remains in excess of 5 years. As you would expect, the majority of our portfolio is comprised of industrial property here in Auckland, the strongest and deepest market in the country. Turning the page -- Slide 10. As June 30 -- as at June 30, independent valuations were completed on 14 of our properties, then the main had -- either had significant leasing or careful works undertaken. Its top valuations were undertaken on the remainder of the portfolio. As a result, the value of our portfolio reduced by just $7.8 million or 0.5%. The portfolio yield is now 5.74%. Instant -- sorry, post June 30, several recent sales of industrial property have now been completed at yields as low as, and in some case, firmer than pre-pandemic levels. You can now turn to Slide 11. This table summarizes the larger leasing transactions that took place during the period. As noted at the side of the slide, more than 80% of these deals were renewals to existing tenants. Again, confirming that our properties continue to remain functional and fit for purpose. The feature of this leasing work during the period has been the length of lease that tenants have been prepared to take. On average, 6.4 years and the low levels of incentive we have been offering, less than 2 weeks per year of 2. You can turn to Slide 12. Rent reviews were completed on 53 leases during the period, resulting in an average annual uplift of approximately 4.1% on $22.5 million of contract rent. Pleasingly, 5 of these reviews were to market, and these delivered an annualized increase of 7.1% over an average review period of 2.4 years on $1.2 million of contract rents. CBRE are forecasting more muted rental growth in the coming years, with prime rents forecasted to increase by an average of 2.1% per annum over the next 5 years, this is down from 3% they were forecasting in December 2019. Around 44% of our portfolio is subject to some form of lease event during the second half of 2020. Moving to Slide 13. You can see on the table on the top right that as at June 30, we had just 1.9% of the contract rent due to expire in the second half of the year. Post June 30, leasing demand has remained strong. Transactions totaling $5.1 million have either been executed or in advanced stages of negotiation, meaning we have dealt with a further 0.8% of our expiries, leaving just 1.1% of contract rent to be dealt with before the end of the year. One point to note is that as landlords, including PFI, look to secure income, growing lease incentives as a trend we've started to see come back into the market. I'll now hand things over to Craig. Craig?

Well, thanks, Simon, and good morning, everyone. Before we dive into the financials, I just wanted to give a brief update on our ESG activities. So following the development of a high level ESG strategy in 2019, in March of this year, we welcomed Sarah Beale as our Sustainability, Risk and Compliance Manager. Sarah has been deepening our ESG efforts, including the establishment of a management committee for ESG and refreshing our health, safety and well-being framework. Looking forward, with sizing up the meaningful steps we can take to enhance our ESG performance with implementation to ramp-up in the new year. Now turning to the interim results, starting from Slide 15. Before we dig into the details, as Simon has already touched on, PFI has recorded a resilient interim result with interim profit after tax of $15.6 million, funds from operations earnings up 6.5% from the prior interim period to $0. 0478 per share. Adjusted funds from operations, earnings down 7.8% from the prior interim period to $0.0379 per share. And cash dividends for the first half of 2020 of [ $0.037 ] per share, which is in line with the last -- with the prior period. So let's dig into these numbers a little bit. Please turn to Slide 16. First up, we take a look at net rental income, which is $41.6 million was in line with the prior interim period. Looking a little closer at the details. COVID-19 related support for our tenants has included $0.7 million of abatement and $0.7 million of deferral, a combined total of 1.6% of annual rent. This support has been directed to our most vulnerable tenants as we seek to balance the health of our tenants with our obligations to our other stakeholders. These abatements and deferrals resulted in a $1.1 million decrease in net rental income when compared to the prior interim period. But accounting entries required as a result of these same deals resulted in PFI recording $0.9 million of income not received and this results in a net change to reported net rental income of just $0.2 million. Other changes that are illustrated on the slide, perhaps 1 thing to call out, is how recycling out of nonindustrial assets is playing out. As you can see, new assets contributed $1 million, which is balanced by the loss of $1.3 million of rent on disposals. Moving now to Slide 17. Here, we see how the activity for the first half of 2020 has translated into funds from operations and adjusted funds from operations, FFO and AFFO. FFO earnings of $0.0478 per share was $0.29 or 6.5% ahead of the prior interim period, whereas AFFO earnings of $0.0379 per share was $0.32 or 7.8% down from the prior interim period. Looking at the drivers of these changes, current tax was down $1.6 million following the reintroduction of depreciation deductions on building structure for commercial and industrial buildings. Interest expense and bank fees were also down with an increase in average borrowings more than offset by a reduction in the company's weighted average cost of debt, which is now just 4.17%. On the other side of the ledger and impacting AFFO, maintenance CapEx was up $1.8 million to 29 basis points and accounting entries for the COVID-19 related abatement and deferral deals of $0.8 million were adjusted out of AFFO earnings. So if you could please now turn to Slide 18. Speaking now about dividends, the PFI Board has today resolved to pay a second quarter dividend of $0.018 per share, in line with the dividend paid for the same period in the prior year. The second quarter dividend will take dividends for the first 6 months of 2020 to $0.036 per share, also in line with the prior period, resulting in an FFO payout ratio of 80% and an AFFO dividend payout ratio of 101% based on the midpoint of our dividend guidance range for the full year. The dividend reinvestment scheme operated for the first quarter dividend and will operate for the second quarter dividend too at a discount of 2%. Looking forward, we're pleased to be in a position to reinstate dividend guidance, and we once again expect to pay a total cash dividend for the 2020 year of $0.0765 to $0. 077 per share, and we expect that this level of full year cash dividends will approximate 80% to 90% of FFO earnings and 95% to 100% of AFFO earnings, in line with our dividend policy. Now this guidance is, of course, subject to being non material to these changes and conditions, unforeseen events, material tenant failures or further material COVID-19 restrictions, 1 or 2 health warnings there. Looking now at the balance sheet. Here, we provide more detail on the changes in value of PFI's investment properties, which is still valued at around $1.47 billion. Included in that total is PFI's property at 127 Waterloo Road in Christchurch, which we now classify as an asset held for sale as it's due to settle in April 2021. We've also got some developments into our projects at 59 Dalgety Drive and 314 Neilson Street, which will both be completing around the end of this year. As Simon mentioned, all 93 properties abated at the half year, 14 full valuations and the remainder of this stock valuations. And the result of that process was a small write-down of $7.8 million or 0.5%. Turning now to Slide 20, where we look at NTA. NTA per share at the end of the interim period was [ $0. 2048 ] per share and that's largely unchanged from the beginning of the year. A small reduction of $0.007 or 0.3% was driven by a small increase in retained earnings and insurance proceeds, offset by a small decrease in the fair value of investment properties and a decrease due to the fair value of derivatives also going down. Moving now to Slide 22 and the capital management section of the presentation. As Simon touched on at the beginning of the presentation in response to the risks associated with the COVID-19 pandemic. In March 2020, we secured a new $50 million liquidity facility from one of our key banking partners, CBA. The new 18-month facility was in addition to the bonds and syndicated bank facility already in place. Securing this additional liquidity gave us almost $130 million of undrawn facilities, which allows us to meet our capital commitments regardless of the progress of our divestment program. The weighted average term to expiry of our bonds in that facility stands at 3.4 years at the end of the interim period, and we ended the half year with gearing a shade out of 29% and interest cover a shade over 4x. Looking forward, whilst the bank loan market remains supportive of PFI, subject to market conditions, we will consider another bond issue to further extend and diversify our borrowings. Moving over to page -- Slide 23. Nothing too much to say on this slide, just a couple of nice graphs for you all. But the one point to draw out is that our hedging profile provides for an average of around 58% of [ debt to be ] used at an average tax rate of 3.44% for the remainder of 2020, with the remainder on those incredibly low float interest rates. So turning to Slide 25 now for a quick update on the markets. New Zealand economy has been able to return to something closer to normal than many other countries but the broader economic outlook is a challenging one. And given these conditions, ANZ and many others now forecast negative interest rates to arrive in April 2021. If we drop down into the industrial property market, things are a little more upbeat and CBRE predicts that the outlook for Auckland vacancy and yields has actually improved since December 2019. Prime vacancy is forecast to reach just 1.1% at the end of their 5-year forecast period and secondary vacancy is expected to behave in a similar manner, reaching just 1.7% at the end of that 5 year forecast. Prime yields are expected to reach 4.74% and secondary yields are expected to contract to 5.65%. Their outlook on rent is a little softer, averaging 2.1% growth for prime properties and 1.6% growth for secondary properties. And as Simon mentioned earlier, that softer outlook is a result of more generous incentives being offered to the prospective tenants. Boiling all of that down, mix of factors bodes well for industrial property, which is performing better than other types of property. So look, that's all for me for now. I'll hand you back to Simon. And of course, if you have any questions, I'm available at the end to answer these. Over to you, Simon.

Thanks, Craig. I'm now on Slide 27 of the presentation. As we've previously articulated, our purpose here at PFI is to generate income for our investors as professional landlords. We have the vision of being one of New Zealand's foremost listed property vehicles. To achieve this, we laid out a very clear strategy. This included transitioning to a pure industrial property company, over time increasing our Auckland focus, the continuous improvement of the property and tenant fundamentals within our portfolio and working to decrease the age of the portfolio. Pleasingly, we've made significant progress with this strategy, which is illustrated on the following slide. You can see along the top line since Q1 2019, we've invested over $130 million into a series of quality acquisitions and capital projects. This investment has been balanced out against 4 divestments of nonindustrial or noncore property, totaling $47.8 million. Turning to Slide 29. You can see that despite the onset of COVID and the disruption this has brought, we remain focused on 4 key areas: firstly, completing the disposal of the remaining nonindustrial properties we own, Carlaw Park and Parnell and Shed 22 down in Wellington. Secondly, looking to match these divestments with additional acquisitions of industrial property. Thirdly, completing the capital projects that are currently in progress and at the same time, looking to advance other opportunities within the portfolio. And finally, continuing the day-to-day management of the existing portfolio to maximize returns for our shareholders. Turning to the final slide, number 31. We are pleased to deliver a very resilient interim result despite a period of significant volatility and uncertainty. The result we have announced today not only reflects our ownership of the right industrial properties in the right locations leased to strong tenants. It reflects the work we've been doing over the previous periods and ensuring we have maintained conservative levels of gearing and dividend payout ratios. Looking forward, as always, there's going to be some challenges, but we believe that PFI will be well placed to respond to these. And just as importantly, we are ready to take advantage of the opportunities that will no doubt present themselves as well. That now concludes the presentation. Thank you. We would welcome any questions you may have.

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

The first question is just around abatements and deferrals. Obviously, they came in nice and low. Just in terms of second half '20 and Auckland going back into level 3 there for a period. Do you see much need for abatements or deferrals in second half '20, new ones?

It's Simon here. As we stand, minimal would be my description. It's, I'm going to say, under Level 3, the majority of our tenants continue to operate, have access to the buildings and are able to operate on a fairly normal basis. Some of the smaller cafés that we have in one of our properties, that sort of tenant. But in general, nothing like lockdown 4 the first time around.

Yes. And down at Carlaw Park and how are Quest, I think, they were coming out of the shutdown in the first half pretty well. How are they traveling through this at the start of the second half?

Yes. Again, Quest is a pretty much a domestic based hotel chain or apartment chain. So yes, they came out of that first lockdown fairly well. We actually haven't had them report to us yet on the second part. So again, I think, the quicker we get out of Level 2.5, as it's referred to, the better for everyone. But we haven't really had a full result from them.

Sure. And then just in terms of -- as you look across the portfolio, I mean, are there -- you haven't really called anything out. So assume it's okay. But are there any meaningful tenants where you're concerned about that qualifier you gave on the guidance and any potential for tenant failures?

It's Craig speaking, Arie. I mean, I think, there's obviously tenants who are happy to work with you if they are in difficulty and we much prefer that. But from time to time, you get a letter from a liquidator, which is never a nice letter. And so nothing on the horizon, but we also don't know what we don't know. So -- and we're conscious that there are a lot of people doing it very tough out there, right across the economy, so conscious that there's a potential for that.

Yes. And you called out the likelihood of increased incentives sort of being a feature in the market, but also sort of, I think, sort of mentioned that and what you've done to date in terms of re-leasing, it hasn't been to that -- what is sort of the expectation as you go through leasing up the rest of what you've got for this half and into next year? Do you expect to -- for the -- to see some increase in the incentives you're giving?

Yes. I think it's fair to say. If you look at the first -- or the period we just reported on, we were sort of saying 2 weeks per year of term. So we've got 3 months for a 6-year lease. I would say it's probably 2 to 4 weeks now on a case-by-case basis. So you might be given away 4 weeks for a new tenant into the portfolio, whereas a renewal, obviously, is less. So again, it's always on a case-by-case basis, but -- and talking to the other landlords and the agents in the market and centers have come back. So -- which, again, if you go back 3 or 4 years, it was not unusual. It was pretty standard. So a little bit of a return to normal. Landlords have had a very good last 36 months, really, so part of the cycle here.

Yes, sure. And just turning to Carlaw Park and the divestment there. Any prospect that you'll kick that off in this calendar year? Or do you think it's still most realistic that, that will be something that you start marketing in FY '20?

We're really just watching what's happening in terms of these alert levels. We're meeting with potential agents on a pretty regular basis. We've sort of said in the next 6 to 12 months. So yes, we'll make a decision later on this year.

So I mean positive, obviously, with the Jacobs space. I mean, what sort of the time -- I understand -- is it Wilson that sort of you've got a renewal coming up? Or when do you sort of expect to sort of work within through that? And is that sort of a precursor to marketing?

That is one of the pacing items. It's fair to say. We've got a renewal of Wilsons next year. And obviously, car parking has been one of the tenancies within Auckland, Central Auckland, that's taken a bit of a hit. So yes, we've got a good relationship with Wilsons, and we're working through things at the moment.

And do you think that you could sort of sign up something new in this calendar year?

It would be the intention.

Yes, great, right. And then just final question, just on the DRP. Do you have a view on how long you're going to let that run that?

No, we just take that on a case-by-case basis, Arie. So that's each quarter, it's a decision that the Board makes. We don't sort of forecast any further than a quarter ahead on that.

Our next question comes from Nick Mar from Macquarie.

Just a quick 1 on the kind of outlook. The range you gave for AFFO, is that actually a forecast, or is that just applying the kind of 95% to 100% [ just on the deferral ]?

Yes. It's just the implied earnings that roll out of the dividend guidance range. So yes, it's not a...

So do you reckon you could get to the [ 8.1 ] or so since the new situation? Or...

Well, that would be nice. Wouldn't it? No, look, it's nothing more than just -- there's nothing more than just simply saying, we know, that if you've got a dividend guidance of $7.7 million and you -- and that represents a 95% payout ratio, then what does that imply in terms of the earnings that you would have to get [ to ahead ] that's nothing more than that. So, yes.

Okay. No, that's clear. Given the kind of move in market rental outlooks, where do you think you guys are kind of sitting in terms of under-renting in Auckland versus, I think, the end of last year, you were saying kind of 6% under?

Yes. Look, I think, we've explained this before. That's an internal calculation based on sort of looking at market data and that sort of thing, I guess, the 3.5% that the valuers came up with is a little bit softer than that 6.5%, I think it was we had at the end of the year. So yes, it's somewhere between those 2 numbers. As Simon mentioned, it's definitely backed off a little bit with people incentivizing new deals. So the under renting almost certainly come back a little bit.