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

Thank you all for standing by, and welcome to the Property For Industry 2021 Annual Results Presentation. [Operator Instructions] I'd now like to hand the conference over to CEO, Simon Woodhams. Thank you. Please go ahead.

Good morning, everyone, and welcome to PFI's 2021 annual results briefing. It's Simon Woodhams speaking, CEO of PFI. And alongside me today is Craig Peirce, our Chief Finance and Operating Officer. This morning, Craig and I are going to speak to the topics on the contents page on Slide 2 of this presentation. I'm going to begin by reviewing highlights of 2021 and then give an overview of the portfolio and its performance, along with the summary of the key leasing transactions throughout the period. Craig is then going to take you through the annual results and the sections on capital management and ESG before giving a brief update on the market. I'm then going to review our priorities before I close the presentation, and there's an opportunity for participants on the call to ask any questions you may have. So if you would all turn to Page 4 of the presentation headed highlights. We'll make the beginning. So we're really pleased to report on what was an incredibly busy year for us here at PFI. Highlights that Craig and I will expand on throughout the presentation included a record annual profit of $392.5 million which are funds from operations and adjusted funds from operations improving by significant amounts from the prior year. Our balance sheet is in great shape with our NTA increasing by approximately 37% to $3.03 per share and our gearing at 27.7% and the successful refinancing of our bank facilities, we have over $120 million of available liquidity. Continued progress on our strategy means our portfolio metrics, including occupancy at 100% and our weighted average lease term at 5.4 years remains very stable. And finally, today, we've announced the fourth quarter dividend of $0.0245 per share, resulting in cash dividends for the year of $0.0709 per share. This is an increase of approximately 2.6% on last year's dividends. If you'd now turn to Slide 6. Here, we have a summary of the portfolio statistics as at 31 December. You can see that over the year, the company increased a number of properties we own to 97 while reducing the number of tenants we managed to 136. This was a direct result of divesting out of the mixed-use asset Carlaw Park. Over the last 12 months, the value of the portfolio increased by approximately $537 million to $2.17 billion. Pleasingly, we grew contract rent by close to $6 million. We also ended the year with a weighted average lease term of 5.4 years. And as I mentioned earlier, the portfolio is 100% occupied. Finally, with the settlement of Carlaw Park, our portfolio is close to 100% industrial with the majority being held here in Auckland. If you turn to Slide 7, which is headed Valuations. So during the course of 2021, the strong demand for industrial property continued. We recorded an increase in value from independent valuations of ZND392.5 million or 22.2% to $2.17 billion. Around 90% of this growth was as a result of cap rate compression, which show our portfolio yield firm over 100 basis points to 4.41%. This growth, as I mentioned earlier added $0.8205 to our NTA, which now sits at $3.03 per share. As noted, our valuers have estimated the portfolio is approximately 3% under-rented. If we move through to Slide 8. A strong and busy year of asset management saw us lease 150,000 square meters or about 20% of the portfolio. We completed 29 transactions, 10 to new tenants and 19 renewals with existing tenants for an average lease term of 6.7 years. To secure these leasing transactions we provided an average incentive of approximately half a month per year of term. Pleasingly, a positive re-leasing spread of 12% was achieved on the stabilized renewals. Turning to Slide 9. We will review the upcoming lease expiries. If you look at the bar graph to the bottom of the slide, you can see that we have just 6.4% of contract rent due to expire during 2022. This is well below recent years, where historically, we've had around 10% due to expire at the start of the year. The largest single expiry this year is a lease to Southern Spars out in Evendale, and this accounts for 28.7% of the total expiry. Looking forward to 2023 and 2024, you will note a reasonable increase in upcoming expiries. This is predominantly due to 2 brownfield opportunities coming into play, which I'll discuss a bit later in the presentation. When these are excluded, a more traditional lease profile is forecast. If we turn to Page 10. 114 rent reviews were completed during the period, resulting in an annual uplift of approximately 3.5% on $66 million of contract rent. Of these reviews, 10 with market, and these delivered an annualized increase of 2.3% over an average review period of 5 years on $4.9 million of contract rent. CBRE are forecasting strong rental growth in the coming years with prime rents pass to increase by an average of 3.9% per annum and secondary rents to increase by 3.7% per annum over the next 5 years. Around 75% of our portfolio is subject to some form of lease event during 2022, which will continue to allow PFI to benefit from ongoing retinal growth. I'm now going to hand over to Craig, who's going to speak to several topics, including a review of the annual results. Craig?

Great. Well, good morning, everyone, and thanks for tuning in. As Simon mentioned earlier, we're pleased to share with you a record annual results for the company. Annual profit after tax totaled $452.8 million. Funds from operations are up 14.4% to $0.1107 per share. Adjusted funds from operations are up 15.7% to $0.0929 per share and cash dividends of $0.0709 per share or up 2.6% on 2020 dividends. So let's dig into these numbers a bit. Please turn to Slide 12. On this slide, we take a look at net rental income, which is $94.3 million is up $10.1 million or 12% on the prior year. Heading to net growth where increases due to acquisition activity totaling $7.3 million and positive leasing activity totaling $5 million. On the other side of the ledger, decreases were predominantly due to disposals and vacancy, totaling a combined $1.7 million. Moving now to Slide 13. On this slide, we see how the year's activity has translated into adjusted funds from operations, or AFFO. As headlined in [indiscernible] AFFO earnings of $0.0929 per share were up $0.0126 per share or 15.7% compared to 2020. The lion's share of this increase was due to net rental income, which including AFFO adjustments, was up $11.2 million or $0.0223 per share. There were several smaller increases in expenses offsetting some of this growth, including an increase in admin expenses due to the expensing of an IT project and an increase in maintenance CapEx. If you could now turn to Slide 14. Turning our attention now to dividends. The PFI Board has today result had fourth quarter final dividend of $0.0245 per share, with the dividend reinvestment scheme not operating for this dividend. This fourth quarter dividend will take cash dividends for the year to $0.0709 per share, up 2.6% on 2020 dividends, resulting in a fund from operations dividend payout ratio of 71% and an AFFO dividend payout ratio of 85%. The dividend per ratio based on PFI's revised dividend policy is 92% of AFFO on a rolling 3-year historic basis. Strategy progression, a fully occupied industrial property portfolio scale and bond industrial property market conditions mean that the PFI Board expects to declare 2022 cash dividends between 8.05 and 8.10 per share, a further increase of up to 2.5% on 2021 dividends. Those cash dividends of $0.0805 to $0.081 per share are anticipated to result in a dividend payout ratio at the bottom of PFI's dividend policy range with this guidance subject to the caveats listed on the slide. Turning to Slide 15. Looking now at the balance sheet, here, we provide more detail on the change in value of PFI's investment properties, which including 6 held for sale, valued at almost $2.2 billion. The increase from $1.63 billion at the end of 2020 was driven by the $393 million valuation gain that Simon talked about earlier as well as $226 million of acquisitions. Significant CapEx redeveloping 59 Dalgety Drive, developing 47 A Dalgety Drive and completing new Breezway Canopy at 124 Hewletts Road, amongst other things, contributed further $20 million. Disposals include Carlaw Park, which settled in December and 127 Woodley Road, which settled in April, and these reduced the book value of the company's portfolio by $107 million. So turning next to Slide 16, where we look at net tangible assets, or NTA, which increased by $0.8205 per share or 37.3% from $221 per share at the end of 2020 to $3.03 per share at the end of 2021, breaking the $3 per share mark for the first time in the company's history. The $393 million increase in the fair value of investment properties contributed around $0.78 per share to that increase. So moving now to Slide 18, capital management. This slide provides more details on PFI's strong balance sheet. All of the company's bank facilities were refinanced during the year and a further $125 million facilities was added. At the end of the year, the weighted average term to expiry of PFI's bonds and bank facilities was 3.9 years, and the company had over $120 million of available liquidity. Year-end gearing was just 28% and the interest cover ratio for the year was 4.4x. Looking forward, we're considering our options, including a third senior secured bond issue to further extend the tenor and diversify the source of our borrowings. Moving to Slide 19. On this slide, the graph at the top shows the facilities I just spoke about as well as our 2 bonds, Manhattan, if you will, of bank and bond facilities. The bottom graph illustrates our hedging profile. Now this profile provides for an average of 66% of our debt to be hedged at an average fixed rate of around 2.5% during 2022, which offers some protection from forecasted rising interest rates. Turning now to Slide 21, for an update on ESG. A couple of years ago, PFI developed a new ESG strategic framework. Despite the challenges over the last couple of years, we're really pleased with the progress that we're making on delivering against that framework, and this slide sets out some of the highlights for 2021. Firstly, we began placing -- we began replacing environmentally harmful R-22 refrigerant gases and our heating ventilation and air conditioning systems with a more modern gas that has a much lower impact on the environment. This contributed to a reduction in our direct [Audio Gap] during the year. Second, we continue to build out our capability to evaluate and respond to climate-related risks and opportunities. You can find our second round of TCFD disclosures in our annual report. We also continue to support our tenants, our team and our community through the ongoing challenges of the COVID-19 pandemic while maintaining our focus on health, safety and well-being. And finally, we took positive steps to address our indirect carbon emissions associated with our supply chain by creating a pathway for Green Star certification on future developments and a framework that will help us undertake refurbishments in a more sustainable way. Please turn to the next slide, #22, to dig into sustainable refurbishments a little further. So to bring that topic to live a little more, our refurbishment of 3 to 5 Niall Burgess Road is a great example of how we're able to reduce our indirect environmental impacts while completing refurbishments in a more sustainable way. When Electrolux leased at 3 to 5 Niall Burgess was due for renewal, sustainability was at the front of the mind for them when considering newer options. PFI was able to offer a proposal to retain Electrolux as a tenant by completing a refurbishment that enhances operational efficiency of the building. For example, by installing LED lighting. We're also taking care to manage the impact of refurbishment works. For example, by ensuring the refurbishment waste is recycled where possible. And importantly, rejuvenating this existing building has a significantly lower environmental impact when compared to developing a new building as the majority of the steel and concrete is already in place. Going forward, we'll continue to progress initiatives across all of our ESG strategic themes and in particular, we're really focusing on our environmental impact. This will be a journey of many years to come for PFI, and we look forward to continuing to sharing our progress on this journey with you. Turning now to Slide 24 for a quick update on the market, before I hand you back to Simon. As can be seen on this slide, the e-commerce penetration accelerated by the COVID-19 pandemic has continued in 2021 with significantly higher levels of online sales in '21 as compared to 2020 and '19. As we previously noted, online sales growth is expected to drive additional demand for warehouse space. And PFI's portfolio is set to benefit from this systematic both directly but also through strong forecast rental growth and continued low levels of vacancy. CBRE's latest forecasts are presented on this slide, further into growth is forecast, reflecting favorable supply-demand conditions and there's also been a slight improvement in the outlook on yield and vacancy since the middle of 2021. That's all from 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 am now turning to Slide 26. So before we review how we went last year on our main areas of focus, it's important just to step back and review what our purpose, vision and strategy is here at PFI. As we've stated before, we see our purpose very clearly as generating income for our shareholders or investors, and we do this as professional landlords to the industrial economy. If we do both of these things well, we will have a positive impact on the wider New Zealand economy. Our vision sets out what success looks like to us. Our driver is to be best-in-class at what we do and we assist that against 4 key measures: those being performance, quality, reputation and scale. And our strategy acknowledges that it requires us to be intent and proactive and as a management team to continually build on what we already have. The way we look at it, our strategy prevents us from just being a passive investor right in out what has been a very strong rising market to date, instead, the emphasis is on deliberately prudently creating value for our shareholders. And essentially, this is done by -- moving to Slide 27, focusing on first-class management and looking to continually improve on our portfolio. Both of these are actions you would or should be expecting of us here at PFI. If we jump through to Slide 28, where we break down the composition of our portfolio into 4 categories or buckets. Thinking about the portfolio in this way, we have target ranges for each bucket. We can focus on each of these areas and drive growing returns for our shareholders. As at the 31 of December our portfolio was comprised of 79% of core generic properties, 10% of brownfield opportunities, 1% of assets held for sale and 10% of specialized assets. The portfolio had an approximately -- sorry, an approximate 80-20 split across Auckland and the rest of New Zealand. All of these are within our target bands. The next slides review each of these areas in further details. So if you turn to Slide 29. In May, we announced the acquisition of 44 Noel Burnside Road in Wiri for $92 million. This was purchased with an initial 2-year lease in place, providing a yield of around 4%. Because of the shorter initial lease term, we originally viewed the purchase as a brownfield opportunity. At the time we purchased the property, we noted that due to its location, it's directly adjacent to the Southwestern Motorway in Wiri, and the quality of the improvements, we were confident of re-leasing it once it became available to the market. Pleasingly, we managed to facilitate an early lease [indiscernible] with the original tenant [indiscernible] with a new 10-year lease to Cottonsoft the toilet paper manufacturer on a commencement rental of $3.32 million, with fixed annual increases of 2.5% and a midterm market review. As a result of this new lease, we have moved this property into our core generic holdings bucket. Moving to Slide 30. In November, we announced a further acquisition at this time of a specialized asset located in Whakatu in the Hawkes Bay. This 9.56 hectare site was acquired by way of sale and leaseback transaction with PNG Global, an NZX listed business specializing in the growing and exporting of projects. The property was purchased for $79.5 million with a 15-year triple net lease in place and is comprised of 36,000 square meters of post-harvest operations along with 3.7 hectares of storage yards. The commencement rental at $3.5 million reflected an initial yield of 4.4%, and fixed annual reviews will ensure ongoing rental growth. Over the medium to long term, we believe there is -- there will be opportunities to invest further capital into the site as T&G look to continue the expansion of their operations in this area. Turning now to Slide 31. Here, we highlight 3 smaller acquisitions we undertook in the back half of the year. Each one of these acquisitions were strategic in nature and that they are all adjacent to neighboring properties already held by PFI. While each one of these properties are valued below $7 million, they all provide medium- to long-term opportunities of adding value to our existing properties. For example, the property at 318 Nielson Street, which we settled on in March is a 5,000 square meter yard that when incorporated in the redevelopment of the neighboring 304 Nielson Street will allow for the creation of a ring road, thereby allowing for greater site coverage and more efficient truck movements on site. Pleasingly, all 3 of these transactions were completed off-market with minimal competition. If you turn to Slide 32. One of our upcoming brownfield opportunities is with our property located at 30 to 32 Bowden Road in the heart of Mt. Wellington. The property has a final lease expire in the first quarter of 2023, and our redevelopment plans was 3.9 hectare site have been well advanced during the last 6 months. We have the ability to construct up to 20,000 square meters of modern warehouse facilities with the intention to begin the construction in Q2 2023 once the existing tenant has vacated the site. We're anticipating approximately $50 million of capital into this project and to date, we have received good levels of lease and inquiry, reflecting the current strength of the industrial property market Craig spoke to earlier. Moving through to Slide 33. Pleasingly, Bowden Road is only one of several significant brownfield opportunities that we have coming through over the next few years. As you can see on this table, approximately 10% or $224 million of our portfolios held in this category. Each one of these properties are comprised of parcels of land located in key precincts here in Auckland. When the time comes to redevelop these properties, PFI will have the opportunity to deploy capital on the projects that will create eastern class product with accretive returns. All these projects are completed. All these projects are completed -- once these projects are completed, with leases in place, they will be transferred into the core generic category. Turning to Slide 34, where we highlight assets currently held for sale. With the divestment of Carlaw Park completed and the sale of 48 Seaview Road, Wellington settling shortly, our mix sale will be Shed 22, a waterfront bar and function center down in Wellington. We're due to finish a small series of size and suites at this property in early April, after which we will take this property to market. After these sales are complete, we expect our pro forma gearing to sit below 27% with 83% of the portfolio based here in Auckland. If we move through to the final slide of the presentation on Page 36. So to summarize, we're very pleased to deliver what was a very strong set of results. Industrial property as an asset class that has continued to perform very well. Demand from occupiers remains robust, supported by record low levels of vacancy and projected rental growth. Pleasing our portfolio and strategy are benefiting from these dynamics. Looking forward, as always, there may be some challenges, but we believe that PFI is well placed to respond to these and just as importantly, we are ready to take advantages of the opportunities that will no doubt resilient themselves as well. Thank you, that concludes the presentation. Craig and I would welcome any questions you may have.

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rohan Koreman-Smit at Forsyth Barr.

Craig and Simon, congratulations on a good year. Just looking at this brownfield pipeline. I was just wondering if you could give us some color. We know construction costs are going through the roof. But are you able to kind of give us a bit more color around kind of where rents need to be versus current rents? And I guess, what kind of yields you're thinking of?

Yes. So at a very high level, we would agree that construction costs at the moment are differently elevating. And when we're talking through our construction partners, they're putting in reasonable ranges of construction or forecast construction inflation of circa 4% to 8% on an annualized basis, depending on what we're looking at. So in terms of rents needed to get these developments off the ground, I think it's pretty common knowledge now that you're well over $150 a square meter on the warehouse rates. And there have been recent deals signed. We understand at that sort of $150 to $160 per square meter. So there's definitely an elevation there. And then in terms of returns, and again, a big part of it is what you put your land in and some people count it some discount it. We are thinking return on cost, including land for these developments. We'll sit around that 4.5% to early 5% range depending on all those factors coming together. So there's still some margin on it when you look at what prime yields for completed projects are sitting below 4% still. So yes, but it's definitely a moving beast. So we're very conscious of that, and it will be interesting to see how we lock it down over the next 3 to 6 months with Bowden Road.

And then when you look at, I guess, asset values, and you just mentioned at the prime sub 4. What's the kind of internal view on where yields will go?

I think you'll probably start to see a bit of a divergence between prime and secondary in C-grade. I think there will still be a good market for that prime stuff and a big underlying factor of that is obviously the amount of capital in the market but also the rental growth story. It's a pretty strong one. So I think there will be a holding of value for that high-quality stuff. Some of that secondary and C-grade stuff that might come off a little bit. But I just think there's so much money out of the market. I know interest rates are moving up and forecast to move up where they actually end up 9s really too sure on. And then that growth story around the rental piece will underpin a lot of what happens over the next 12 to 18 months.

We have no further questions in the queue. Oh, sorry just a final call before we wrap up. [Operator Instructions]

I was just going to say, Tara, we can see that there's no further questions. I know Craig and I have got a busy couple of days catching up with people. So happy to take questions now or when we catch up with people, whatever anyone would prefer. We won't draw down any longer Tara. So as I said, hey, everyone, thank you very much for dialing in. Obviously, things are a little bit different with COVID, although it's the same as the last 2 years, but we'll be zooming in with a good significant chunk of our investors over the next 2 to 3 days. But if anyone does have questions, and they're not catching up with us, just feel free to pick up the phone to Craig or myself, the details are on our releases and obviously, on the website. We enjoyed talking to our investors, whether they're private or others. So thanks very much for your time this morning, and we look forward to speaking to a lot of you in the next 2 or 3 days. Thanks a lot.

Thank you very much, gentlemen. Ladies and gentlemen, that does conclude our call today. Thank you so much for attending. You may now disconnect.