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

Good day, and thank you for standing by. Welcome to the Property For Industry annual results presentation. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to our speaker today, Simon Woodhams, Chief Executive Officer. Please go ahead.

Thank you, and good morning, and welcome to Property For Industry's 2023 annual results briefing. It's Simon Woodhams speaking, the CEO of PFI, and on the line with me today is Craig Peirce, our Chief Finance and Operating Officer. This morning, Craig and I are going to speak to the topics outlined in the contents page on Slide 2 of the presentation. I'm going to begin by reviewing the highlights for the year and give an overview of the portfolio and its performance, along with a summary of the key leasing transactions throughout the period. Craig is then going to take you through the annual results and sections on capital management before giving an update on sustainability. I will then give a brief update on the market, but before reviewing our priorities. I'm then going to close the presentation after which there will be an opportunity for participants to ask any questions they may have. So if you would turn to Page 4 of the presentation, highlights. We are pleased to report on what has been a busy year for us here at PFI. Highlights that Craig and I will expand on throughout the presentation include, our resilient and well-located $2 billion industrial portfolio has performed very well with core assets delivering annualized rental growth of 4.2% across the $68.9 million of contract rent that was reviewed during the period. 18.3% of contract rent was leased during the year with rents were agreed on $14.3 million of contract rent at an average of 26.4% above previous contract rents. The remaining portion is still subject to market [ reviews ] on renewal dates with the entire portfolio approximately 16% under-rented at the end of the interim period. Our Green Star development pipeline has expanded, with a conditional contract to acquire 5.8 hectares of land at Spedding Road in Auckland's [indiscernible], North West. Our active brownfield sites, being 30 to 32 Bowden Road and 78 Springs Road, are on track with around $73 million of committed spend remaining. We continue to make progress on our sustainability initiatives, including advancing power metering and solar initiatives, and of course targeting 5 Green Star ratings at both Bowden Road and Springs Road. Our balance sheet also remains in great shape with $250 million of available bank liquidity at the end of the year and gearing comfortable at 32%. This activity is combined to deliver a stable end result for 2023. Our adjusted funds from operation, or AFFO, is up 1% on FY '22 to [ $0.0892 ] per share. Today we have announced a fourth quarter dividend of [ $0.0245 ] per share, resulting in cash dividends for the year of [ $0.0830 ] per share, an increase of 2.5% on our FY '22 dividends. Finally, PFI's balance date is changing from 31 December to 30 June and PFI's next annual report will reflect the 6 month period to 30 June, 2024 referred to throughout this presentation and the company announcement as FY '24. We now turn to Slide [ 6 ], [ into ] portfolio snapshot. Here we have a summary of the portfolio statistics as at 31 December, including the impact of brownfield leases yet to commence. You can see that the company continues to own a portfolio of 92 properties leased to 126 tenants. Pleasingly, the portfolio remains 100% occupied with a weighted average lease term of 5.06 years, moving to 5.78 years upon inclusion of the brownfield leases. Contract rent decreased as leases at the company's brownfield development sites expired. As you can see here, once the new leases commence at those sites, contract rent moves back to over $100 million. We continue to focus solely on industrial property, with the majority being held here in Auckland. Moving through to Slide 7. During the period the team completed 29 leases over 140,000 square metres of area, or 18.3% of the portfolio by rent, for an average lease term of 5.2 years. Of these 29 leases, 83% were renewals and the remainder were new leases. On average, just 0.05 months of incentive per year of term was required to secure these transactions, reflecting the continued strength of the industrial market. Of the $17.7 million of contract rent secured during the year, rents were agreed on $14.3 million of contract rent, and these transactions were settled 26.4% above previous contract rents. The remaining $3.4 million of contract rent secured is subject to market reviews on renewal. After factoring in review caps, those leases were approximately 18% under-rented at the end of the year and have a weighted average review date of September 2024. Moving on to Slide 8. As I mentioned earlier, the portfolio remains 100% occupied, and as the graph on the left-hand side illustrates, we have just 1.3% of contract rent due to expire during FY '24. Of those due to expire, Mainfreight at 212 Cavendish Drive make up 17.9% of that, totaling 0.9% of total contract rent. Mainfreight have indicated they will be leaving in April '24, at which point we plan to replace the concrete slabs and refurbish the office. This is expected to take about 8 weeks and cost $2 million. You can turn to Page 9. 111 rent reviews were completed during the year, resulting in an average annualized uplift of 4.2% on $68.9 million of contract rent. Around 41% of our portfolio is subject to some form of lease event during FY '24 and FY '24 expiries and market reviews account for 5.6% of total contract rent. Those market reviews and expiries are approximately 30% under-rented at December 2023 after factoring in review caps, providing a platform for further rental growth. Looking forward, CBRE are forecasting rents to increase by 2.9% per annum over the next 5 years for prime properties and 1.8% per annum over the next 5 years for secondary properties. Moving to Slide 10. During the year, we recorded a decrease in value from independent valuations of $140.8 million, or 6.7%, to $2.03 billion, largely driven by the higher interest rate environment, which has eased cap rates. Realized rental growth was estimated to have added around 11% to the value of the portfolio, with the remainder of the valuation outcome due to an increase in yields or cap rates as a result of the higher interest rate environment. As a result of portfolio activity and valuation activity, and excluding the company's brownfield development properties, PFI's passing yield softened by 0.51% to 5.01%, while the portfolio cap rates softened 0.74% to 5.74%. An independent market rental assessment of the entire portfolio was completed as part of the valuation process. This assessment estimates that the PFI's portfolio is around 16% under-rented. I'll now hand over to Craig, who will take you through the end results. Craig?

Thanks, Simon, and good morning, everyone. Thanks very much for tuning in this morning as we share with you PFI's 2023 annual results. Whilst fair value losses on properties of $140.8 million contributed to a loss after tax of $97.8 million, funds from operations were down just 1.8% from 2022 to [ $0.1003 ] per share, and adjusted funds from operations were up 1% on 2022 to [ $0.0892 ] per share, with cash dividends for the year of [ $0.0830 ] per share up 2.5% on 2022. So let's dig into the numbers a little bit. Please turn to Slide 12. On this slide, we take a look at net rental income, which at $94.9 million is down just $800,000, or 0.7% on the prior year. This can be seen from the right-hand side of the chart on this slide, growth on the stabilized portion of the portfolio equated to 3.1% for the year. As Simon explained earlier, 2023 saw PFI's portfolio continue to deliver strong levels of rental growth, which has translated to a positive contribution to net rental income of $3.6 million. The net impact of other activities, such as developments and investments, contributed to a decrease of $4.8 million, with the largest negative item to call out here in the loss of income from the company's brownfield development sites as leases expired and works commenced. Moving now to Slide 13. Here we see how the year's activity has translated into adjusted funds from operations, or AFFO. Under the hood, there are a few moving parts. On the positive side, our effective tax rate of 10.5% was down 3.4% on the prior year, with that change being largely due to an increase in deductible CapEx and tax deductions associated with the redevelopment projects. Net rental income after AFFO adjustments such as lower levels of incentives, was also up $2.2 million, or [ $0.0043 ] per share. The main offsetting factor was an increase in interest of $4.5 million, or [ $0.0090 ] per share, on the prior year. If you please now turn to Slide 14, and turning our attention to the all-important dividends. The PFI Board has today resolved to pay a 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 [ $0.0830 ] per share, up 2.5% on 2022 dividends, resulting in FFO dividend payout ratio of 83% and an AFFO dividend payout ratio of 93%. The dividend payout ratio based on PFI's dividend policy is 90% of [ AFFO ] on a rolling 3-year historic average basis. Looking to the year ahead, favorable market conditions, coupled with a portfolio of [ it ] is around 16% under-rented, provides a platform for the companies to continue to grow rental income. With about 40% of the company's borrowings on floating interest rates, higher interest rates continue to drag on earnings. In addition, a range of economic indicators suggest that 2024 may be a challenging year for businesses. Balancing these factors and others, and noting that FY '24 will be a short 6-month period due to the changing year end, dividend guidance for the 6-month period has been set at [ $0.0415 ] per share, which on an annualized basis is [ $0.0830 ] per share, in line with dividends for FY '23. Cash dividends of [ $0.0415 ] cents per share are anticipated to result in a dividend payout ratio at the bottom of PFI's dividend policy range, after [ prorating ] for that balance date change. Turning to Slide 15, and looking at the balance sheet. Here we provide more detail on the changing value of PFI's investment properties, which including FX held for sale, have made just over $2 billion. The decrease from the end of 2022 was largely driven by that $141 million valuation loss Simon talked about earlier, as well as the Canada Crescent and Sheffield Street divestments. $82.1 million was deployed on CapEx during the year, with the major items being the $64.4 million spent progressing the company's Green Star development pipeline at Bowden and Springs Road, yard works at Paraite Road in New Plymouth, and a warehouse extension in Neilson Street, Onehunga. Turning next to Slide 16, where we look at NTA. Net tangible assets, or NTA per share, decreased by [ $0.2709 ] per share, or 9.3%, from [ $2.9808 ] per share as of the end of 2022, to [ $2.7009 ] per share at the end of 2023, with those valuation losses mentioned on the previous slide being the main driver of that decrease. Moving now to Slide 18 for an update on capital management. PFI launched its Green Finance Framework and concurrently established its inaugural $150 million green loan tranches with long-term banking partners ANZ, BNZ, CBA and Westpac in the middle of 2023. And towards the end of the year, we also made a $25 million draw on our non-bank facility with Pricoa. This draw was for 6 years on a float rate basis with the margin fixed for the duration. A number of changes were also made during the year to the company's shorter-term BNZ facility, and at the end of the year, this facility stood at $100 million with an expiry of 31 March, 2025. These activities have combined to provide funding certainty through to the estimated completion of the company's committed Green Star developments at Bowden and Springs Road. And if we can turn now to Slide 19. On this slide, the top graph shows our bank and non-bank facilities, and the bottom graph illustrates our hedging. And as can be seen by that hedging graph, interest rate hedging provides for an average of 57% of the company's debt to be hedged at an average fixed rate of 2.46% during FY '24, offering some near-term protection from floating interest rates. Turning now to Slide 20. Here we have a bit more detail on committed gearing. Following all currently committed acquisitions, divestments and projects, and excluding any revaluation impacts or general portfolio CapEx, we currently see gearing lifting to around 33.5% in Q1, '25. Adding to that, the $40.6 million required to settle Spedding Road, our gearing lifts [ have ] [ touch ] more to 35% around the middle of PFI's target gearing range. PFI has sufficient capital available within our existing funding envelope for the company's near-term development pipeline. We're exploring funding options for future stages of Springs Road and Spedding Road, which Simon is going to provide an update on those projects shortly. But before he does that, let's talk briefly about sustainability. 12 months ago, we shared PFI's refreshed sustainability strategy with you all. One of our key commitments within this strategy was targeting 5 Green Star ratings for significant new buildings, and our 3 buildings under development at Bowden and Springs Road are well on track to meet this commitment. As shown by the case study on the right-hand side of this slide, Green Star is a holistic tool, which covers a range of sustainability areas. Key achievements so far at our Springs Road project include a 7% reduction in upfront carbon emissions of the building because we've designed it in a way that reduces carbon emissions when compared to a traditional design. But we also achieved a massive 98% diversion of demolition waste from landfill, which we're really pleased to report. Importantly, our commitment to Green Star has also enabled us to establish those green loan facilities that I talked about earlier. Moving to Slide 23. Our sustainability strategy also covers our core portfolio, and during 2023, we transitioned to an in-house facilities management model. Repairs, maintenance, and capital projects for our properties are now coordinated by a talented internal team rather than a third-party provider. And this is a range of benefits for PFI, including strengthening our relationships with our tenants. Our [ FM ] team has been hard at work on the sustainability front, installing power metering and monitoring our properties, with 20 installations completed during 2023. This is important as today's PFIs have limited visibility on the operational performance of our buildings. We will need this information if we want to pursue getting green certifications for our existing buildings in the future. The team's also well-placed to help with solar feasibility assessments and installation projects, which will be key to meeting our target of 5 installations by the end of 2025, the first of these being completed during 2023. Turning now to Slide 24. Finally, people are a big focus when it comes to sustainability, and we put a lot of effort into ensuring we have a talented and highly engaged team that delivers to shareholders. We're a strong focus on health, safety, and wellbeing, and we engage with our community in a number of ways. Particular highlights for us during 2023 included the joint fundraiser with Haydn & Rollett, where $45,000 was raised for the Cancer Society, and participating in a team volunteering day at the Christmas Box campaign. That's all from me for now. I'll hand back to Simon, but I'll be around for questions at the end. Simon?

Thanks, Craig. I'm now on Slide 26. I'm just going to touch briefly on current market conditions. As can be seen by this slide, Auckland industrial vacancy remains near historical lows, well below 1% for both prime and secondary stock. These favorable supply demand conditions have led to unprecedented growth in market rents over the past 5 years, with PFI's portfolio now estimated to be 16% under-rented. Looking forward, our strong balance sheet and defensive, well-located portfolio of properties affords us the ability to execute on the company's Green Star development pipeline, while continuing to extract value from our core assets. If you just turn to Slide 27, we'll take a closer look at some of the recent leasing transactions. Our portfolio continues to capture rental growth, with recent leasing transactions secured at benchmark portfolio rents across Penrose, [ we've ] presented 2 examples on this slide. At our Autumn Place estate, a warehouse rate of $185 per square meter has been agreed on a [ 1990s ] -- approximately 2,500 square meter warehouse at 80 Hugo Johnston Drive, representing a 48% uplift on the previous warehouse rate and a 35% uplift on the previous passing rent for the property. Next [ door ] at 4 Autumn Place, a market rent review on renewal has been agreed at a rate of $190 per square meter on a smaller, circa 1,100 square meter warehouse, which is a 44% uplift on the previous warehouse rate and a 43% uplift on the previous passing rent for this property. In both cases, these warehouse rates were agreed at or above the December 2023 value of estimates of market rent. With the [ next ] [ leasing event ] for 17% of PFI's property has been an expiry or market rent review, PFI is well positioned to capture more benchmark rents across our portfolio. Turning now to Slide 29. As many of you on the call today will already know, when we look at our portfolio, we split it into 4 categories or buckets. We do this as it gives us focus and enables us to act with confidence as the portfolio continues to grow. As you can see, all 4 buckets currently sit within their target ranges. Our brownfield opportunities, that is the redevelopment of existing holdings, have been a huge focus for the team over 2023. I'll speak to these shortly, but first a quick update on assets held for sale and to Page 30. You can see here we have divested 2 assets during the year, as well as 15 Artillery Place and 10C Stonedon Drive, which are contracted to be sold and will be settled in March and June of this year. These sales are part of our ongoing asset management program, where we are prepared to move non-core assets on maximizing value and then using the capital to recycle back into better opportunities as they arrive. Turning to Slide 31. As you can see here, approximately $267 million, or 13% of our portfolio is classified as brownfield opportunities. These redevelopments allow us to invest capitals into projects and key precincts, regenerating older assets that we own into best-in-class buildings that will underpin the company's performance for the next 50 years and beyond. Moving through to Slide 32. As the drone footage on this slide illustrates, you can see here things are progressing very well at 30 to 32 Bowden Road in the heart of Mount Wellington here in Auckland. As previously outlined, we have secured a pre-commitment for approximately 40% of the site, with the remainder being developed on a speculative basis. Pleasingly, after receiving significant interest throughout the build phase, we have recently entered into a non-binding heads of agreement for the spec building. The terms agreed include a long-term lease on market rates, with the lease commencement estimated as 1 October, 2024. Both buildings will target a 5 Green Star rating, with close to 24,000 square meters of covered workable area once complete. The estimated incremental project costs remains unchanged at $65 million, and we're targeting a Q3, 2024 completion date for both of these warehouses. Moving through the next Slide, 33. Similarly, the initial phase of 78 Springs Road is progressing very well. As you will recall from last year, our existing tenant, Fisher & Paykel Appliances has committed to the first stage of this significant redevelopment of Springs Road with a 15-year lease. The estimated incremental costs for Stage 1 of the project remains unchanged at $76 million, and again, consistent with PFI's climate commitments, the Fisher & Paykel facility will target a 5 Green Star built rating. PFI has also signed a non-binding heads of agreement with a prospective tenant to develop approximately 6,500 square meters of warehouse, anchoring Stage 2 of the redevelopment. Should this tenant commitment be secured, the balance of Stage 2, approximately 4,800 square meters of warehouse will likely be developed on a speculative basis, and construction could commence as early as Q1, 2025 upon completion of Stage 1. Plans for the balance of the site, Stage 3, allow for a 17,500 square meter warehouse with associated offices and breezeway canopies, with any redevelopment likely to be tenant-led. Moving through to Slide 34. To close out the presentation, I just wanted to touch on our land acquisition in the Spedding Road industrial estate in Whenuapai, West Auckland. During the year, we entered into a conditional contract to acquire approximately 5.8 hectares of land within the proposed industrial subdivision of Spedding Road located at the end of the Northwestern motorway in Auckland, for a purchase price of $40.4 million. There's some details on the diverted settlement date shown here on the slide. Indicative plans demonstrate that the site coverage of around 70% of the lots to be purchased can be achieved, with early concepts allowing for approximately 40,000 square meters of covered workable area once complete, for an estimated total project spend of approximately $150 million, including land. Consistent with PFI's sustainability strategy, all buildings will be designed and developed to target a 5 Green Start rating. Moving to Slide 37. And before I close the presentation, you may have seen we recently announced some board changes to the PFI Board. Jeremy Simpson is joining the Board as an Independent Director. David Thomson has been appointed as the new Chair of our People Committee. Anthony Beverley will be stepping down as Chair of PFI's Board, but will remain on the Board as an Independent Director. Dean Bracewell will be appointed as the new Chair of the Board, and Greg Reidy plans to retire from the Board. So these changes, along with the recent additions of Carolyn Steele and Angela Bull, further strengthen and diversify our Board. Just moving through to the final slide, on Slide 38. So to summarize, we're pleased to deliver this set of annual results. Industrial property is an asset class that continues to perform in the face of a challenging operating environment. Pleasingly, our portfolio and strategy are benefiting from continued low levels of vacancy and escalation in market rents. Looking forward, as always, there may be some challenges, but we believe that PFI is well placed to execute on our current Green Star development pipeline, while at the same time extracting value from our core portfolio, and remaining ready to execute on any opportunities that may arise. Thank you very much. That concludes the presentation. Craig and I would welcome any questions you may have.

[Operator Instructions] And your first question comes from the line of Rohan Koreman-Smit from Forsyth Barr.

Just a couple of quick questions from me. First one, just these big rent increases, how's the discussions with tenants going? I know I ask this every time, but I'm just wondering if the conversations changed a little bit in recent times, given container volumes are off 10% and retail sales are down for probably the sixth consecutive quarter now?

Rowan, it's Simon here. Look, we continue to engage with the tenants very, very regularly. If we've got a large market view coming up, we don't just send that off the week before it's due. So a lot of the transactions that we've talked about today have been on the back of 18 months of engagement with the tenant. There's no doubt that tenants are looking forward to seeing a challenging environment. But when you look around at what else is available out there in terms of low vacancy rates and escalating rents, I think most of our tenants who tend to be operating at the higher level, large corporates, internationals, they're aware of what the market situation is. So whilst they might not really enjoy it, they understand that this is one of the cost bases that has risen sharply over the recent months. So yes understanding, I guess, is how I'd describe it.

And then, are you able to give some yields on your brownfield developments? Kind of where you think Stage 2 at Springs might end up and with the agreement at Bowden, kind of what the final project yield will kind of come in at?

Yes, so in terms of your first one, Stage 2 at Springs Road, we're sort of in that 6% to 6.75% pipe range, which is pretty broad at this stage, you'll appreciate. We're a little way out. In terms of Bowden Road, we're on track to be in that sort of 5.25% to 5.5% return on cost. That's inclusive of land.

And it sounds like you're on the [ tools ] out at Springs Road or Bowden Road -- [ by ] the sound of the background noise.

Yes, that's just a recording that we're playing back in the background for everyone.

Apologies, we understand you can hear a bit of noise. Square outside us here in Britomart is being redeveloped at the moment. So apologies for the background noise.

[Operator Instructions] And your next question comes from the line of Nick Mar from Macquarie.

Just in terms of the [ non-core ] asset sales, I think you sort of flagged 1% to 2% portfolio. Is that sort of -- I know that's sort of your period to review is that -- But can you sort of go through and look at the committed gearing and sort of mid-30s? What's your thinking on how much more we'd like to transact over the next couple of years?

Nick, look, we're constantly reviewing the portfolio, it's fair to say. We're pretty comfortable with the committed gearing over the next 12 months. And we obviously look at all options regarding how we're going to keep this brownfield redevelopment and the Spedding Road stuff going. We've sold a lot over the last 4 years, is what I'd say, nearly $230 million at or around portfolio. So we've always been pretty active in that recycling piece. So yes, read into that what you may, but we continually review the portfolio, it's fair to say.

And then just on the development side, all those further stages that you're looking at, particularly at Springs Road and then, I guess, any indicative work you've done on Spedding Road, how is sort of construction costs and ability to generate return on cost looking on those?

Yes. Again, we're constantly reviewing the numbers. It's fair to say the construction numbers for Stage 2 of Springs Road have, I would say, come back slightly on Stage 1. There's no doub, talking to the construction guys out there and the [indiscernible], that there's a little bit of a construction hole coming up in the market over the next 12 to 18 months. So hopefully we can benefit from that. The materials piece, steel and concrete, have come back quite a bit. Obviously, labor hasn't yet. But yes, we think if we can get into Stage 2 of Springs Road middle of next year, we'll benefit from that.

[Operator Instructions] Your next question comes from the line of Nick Mar from Macquarie.

No, not sure what happened there.

Thank you very much. I will now hand the call back for closing remarks. Thank you.

Hi, thanks everyone for dialing in today. Obviously, we're catching up with a lot of you, both individually and as a group, over the next couple of days. So yes, we look forward to engaging with you then. Any questions you have, feel free to send them through to Craig and I separately. Otherwise, appreciate your time. Many thanks. Cheers. Thank you.

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