Region Group (RGN) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the SCA Property Group (SCP) HY '21 results. [Operator Instructions] I would now like to hand the conference over to Mr. Anthony Mellowes, CEO. Please go ahead.

Thank you very much. And welcome all to the first half FY '21 financial results for the SCA Property Group. My name is Anthony Mellowes, and I'm the Chief Executive Officer. Presenting these results with me today is Mark Fleming, our Chief Financial Officer. Also in the room with me is Campbell Aitken, our Chief Investment Officer; Michelle Tierney, our Chief Operating Officer; and Erica Rees, our Company Secretary and General Counsel. I'm pleased with this set of results as it reaffirms that we continue to remain true to our core strategy of investing in and managing convenience-based centers weighted to the nondiscretionary retail sector. Firstly, let me take you to Slide 4, which sets out our first half highlights. Our net profit after tax of $102.9 million is an increase of 14.1% over the same period last year. FFO per unit of $0.0672 is down by 20% over the same period last year and 8.2% up against the second half of FY '20. Our distribution of $0.057 per unit was down by 24% on the same period last year and 14% up against the second half of FY '20. Our gearing was 29.1%, and our NTA has increased to $2.25 per unit. Our portfolio weighted average cap rate is now 6.39%. Convenience-based assets are still in strong demand from investors, particularly high-net worth individuals or families, as well as some new institutional investors. Investors continue to seek long-term defensive cash flows in a low interest rate environment. Our weighted average cost of debt has improved to 3.2% with 6.2 years weighted average debt maturity. And our portfolio occupancy is 98.2%, and our specialty vacancy has improved slightly to 4.8%, which is within our target range of 3% to 5%. We acquired $178.9 million of assets during the period. Moving to Slide 5, which sets out some of our key achievements that demonstrate how we continue to deliver on our strategy. Our centers are operating strongly. Throughout the COVID-19 pandemic, our convenience-based centers have benefited from the shift to shopping locally. Our anchor tenants have experienced strong sales growth, and turnover rent has increased. Specialty sales have recovered following the easing of restrictions. And we have continued to complete leasing deals with 96 renewals, 63 new lease deals and 70 non-code lease extensions completed during the period. COVID-19 has impacted some of our specialty tenants. While most specialty tenants have experienced significant sales growth, 3 categories have been adversely affected, being apparel, cafes and restaurants and some retail services. We have provided rental assistance to over 800 tenants. And our total cash collection rates have stabilized at around 99% by the end of the period. We've continued to progress in our sustainability program, including commencing a new partnership with The Smith Family. And we've continued to invest in energy-saving initiatives, including efficient lighting rollout and building automation systems, and we have an increased focus on our ESG aspiration and strategy. During the period, we acquired Auburn Central in New South Wales for $129.5 million, Bakewell Shopping Centre and the adjacent petrol station in the Northern Territory for $39.4 million and also some vacant land adjacent to our Greenbank center in Brisbane for $10 million. In December 2020, we also agreed terms to acquire Katoomba Marketplace for $55.1 million from SURF 2. And in January 2021, we agreed terms to acquire Cooloola Cove in Queensland for $18.6 million. Both of these properties will settle in February 2021. The windup of SURF 2 is expected to occur in the second half of FY '21 and will deliver an IRR of 12% to those unitholders. Our balance sheet remains in a strong position. Our gearing at the 31st of December was 29.1%, which is below our target range of 30% to 40%. Our weighted average cost of debt is 3.2%. Our weighted average term to maturity is 6.2 years. And we currently have cash and undrawn facilities of in excess of $200 million. Finally, our funds from operation per unit of $0.0672 represents a decrease of 20% against the same period last year but was 8.2% above the second half of FY '20. And our distribution of $0.057 represents a decrease of 24% against the same period last year but was 14% above the second half of FY '20. I'd now like to hand over to Mark to present the financial results.

Thanks, Anthony, and good morning, everyone. I'll start on Slide 7, which shows the sales performance of our tenants and our cash collection rates during the COVID pandemic. The sales growth shown here is month-on-month, i.e., the relevant month versus the same month in the prior year. And you can see that it's been quite volatile. We had a big lift in supermarket sales in March due to panic buying at the beginning of the pandemic. But even after that, supermarket sales have remained abnormally strong throughout the pandemic period, ending with December month-on-month sales growth of 6.7%. Likewise, discount department stores have performed really exceptionally strongly throughout the period, ending with December month-on-month sales growth of 12.1%. The key driver of the performance of our anchor tenants has been the trend towards shopping locally and staying at home that we've seen throughout the pandemic to date. And that trend is continuing. In relation to specialty tenants, the sales growth has been more mixed. This is partly because many apparel tenants chose to close their doors during the heart of the pandemic, while others, particularly cafes, restaurants and services tenants, were restricted from trading normally by government restrictions. However, you can see that since the end of the Victorian restrictions in October, our specialty tenants overall have traded very well, recording December month-on-month sales growth of 9.9%. We'll talk more about the trading performance of the different subcategories of specialty tenants in a later slide. In terms of cash collection, you can see that we've collected almost 100% of the contracted rental income throughout the half year period. However, rents are taking longer to collect. And the collection rate in relation to first half invoices within 30 days was around 85%, which is below the pre-COVID level of closer to 90%. Moving on to Slide 8, which shows the impact of COVID-19 on our earnings. The first impact of COVID-19 has been waived rent of $4.8 million during the period, of which $2.4 million was granted to SME tenants under the Mandatory Code of Conduct, and $2.4 million was granted to national tenants. We also granted deferrals of $2.5 million predominantly to SME tenants during the period. The second impact is a movement in the expected credit loss allowance, and there are actually 2 underlying movements there. Firstly, the ECL allowance was increased by the deferrals and unpaid rent during the period. However, this was more than offset by a better-than-expected collection of debts from the FY '20 financial year. And that's why the ECL allowance movement is actually a positive contributor to the first half result. Finally, there are a range of other impacts of the pandemic, such as increased cleaning and security costs, rent freezes required by law and reduced casual mall leasing income. And we've assessed those at around $3.8 million. So the total impact of COVID-19 on the first half result is approximately $6.9 million. In terms of AFFO per unit, the 2 main impacts are, firstly, the $6.9 million COVID impact; and secondly, the dilutive effect of the equity raisings that we completed at the beginning of the pandemic. Our aim, once the impact of the pandemic has ended and once we have fully redeployed the equity raising proceeds, is to return to the pre-COVID level of AFFO, which was $0.075 per unit each half or $0.15 per unit per annum. Turning now to Slide 9, profit and loss. Our statutory net profit after tax was $102.9 million, which was up by 14.1% compared to the same period last year. The primary reason for the increase was an increase in the fair value of investment properties partially offset by a decrease in the fair value of derivatives. Stepping down the P&L, you can see that net operating income has decreased compared to the same period last year, primarily due to the impact of COVID on rental income. Corporate costs have increased due to an increase in directors' and officers' insurance premiums and because no KMP STIP was paid in respect to the FY '20 financial year. Fair value of investment properties increased due to a combination of cap rate tightening, improved NOI outlook and reduced allowances for future lost rents due to the pandemic. Fair value of derivatives has decreased by $74.7 million due to the cross-currency interest rate swaps associated with our USPP, and that's due to the appreciation of the Australian dollar and the lower and flatter yield curve. Likewise, the unrealized foreign exchange gain is due to the decreased value of our U.S. dollar debt due to the appreciation of the Australian dollar. Finally, interest expenses decreased due to the weighted average cost of debt reducing from around 3.5% last year to 3.2% now. Moving to Slide 10, funds from operations. To get to funds from operations or FFO, we reverse out the noncash and one-off components of our net profit after tax, including fair value adjustments. As we compare these numbers to the same period last year, we need to keep in mind that the comparable period was before the COVID-19 pandemic began. FFO of $72.3 million is down by 7.9% on the prior year, with the direct COVID-19 impacts of $6.9 million offsetting the contribution from acquisitions. FFO per unit of $0.0672 per unit is down by 20.4% on the prior year, a larger percentage decrease than the FFO due to the dilutive effect of the equity raisings in April and May last year. AFFO of $62.4 million was down by 11%, slightly more than FFO because of an increase in maintenance CapEx. And finally, distributions of $0.058 per unit was down by 24% on the prior year due to the impact of COVID-19 and the equity raisings. The DPU payout ratio was 98% of AFFO. It's a different story if we compare this half year to the immediately preceding half year being the second half of the FY '20 financial year. That is arguably a fairer comparison because both halves were impacted by COVID. That comparison shows that our FFO, AFFO and distributions have all increased strongly as the impact of the pandemic begins to recede. FFO is up by 8.2%, AFFO per unit is up by 7.4%, and distributions per unit is up by 14%. We expect this positive trend will continue in the second half of this financial year. Turning now to Slide 11, which shows our summary balance sheet. Cash has reduced to a more normal level due to utilizing $180 million of term deposits to repay the medium-term note in October last year. The book value of our investment properties has increased to $3.403 billion due to $178.9 million of acquisitions and a $63 million increase in the like-for-like valuation of investment properties. Other assets has decreased due to a reduction in the mark-to-market valuation of our cross-currency interest rate swaps, as discussed earlier. Net debt has increased primarily due to acquisitions during the period. Net tangible assets per unit has increased slightly to $2.25 per unit due to the investment property fair value increase being partially offset by the decrease in the fair value of our derivatives. Excluding the movement in derivatives, our NTA per unit would have been $2.32 per unit. Finally, our management expense ratio has increased due to a $1.8 million increase in our D&O insurance premiums and because no KMP STIP was paid for FY '20. Moving to Slide 12, which deals with debt and capital management. Our gearing sits at 29.1%, which is below the lower end of our target range. During the half, we repaid the $225 million expiring medium-term note. We issued $50 million of new 10- and 15-year notes, and we extended some of our bank facilities. As a result, our weighted average cost of debt has reduced to 3.2%. Our weighted average debt maturity has increased to 6.2 years. We have over $200 million of cash and undrawn facilities, and we have no debt expiring until FY '24. Finally, as you can see, we are well within our banking covenants. Thank you, and I'll now hand back to Anthony for the operational performance overview.

Thanks, Mark. So turning to Slide 14. As we previously mentioned, we acquired 2 convenience-based centers and 1 additional development site. And we are focused on ensuring that our weighting of categories continue to be within the nondiscretionary sectors, being food, medical and retail services. Our occupancy is 98.2%, and the number of our specialties has increased to over 1,900 tenants. 48% of our gross rent comes from majors such as Woolworths, Coles, ALDI or Wesfarmers. And the other 52% that remains are heavy weighting towards those nondiscretionary categories. Slide 15 describes our portfolio occupancy. And our specialty vacancy has remained very stable despite the challenges of COVID-19. Our specialty vacancy has, in fact, reduced to 4.8% from 5.1% in June, which is well within our target range or just inside our target range of 3% to 5%. And our specialty tenants on holdover for our entire portfolio is 1.6%. We had 5 major leases expiring in FY '21. All of these extensions have been agreed. Turning to Slide 16, sales growth and turnover rent. The sales growth in our centers is strong despite some of those specialties being impacted by COVID-19. As Mark outlined on Slide 7, our centers continue to perform strongly. Our supermarkets' MAT sales growth has increased to 8.6%, with both Woolworths and Coles showing strong positive growth. Our discount department stores' MAT sales growth has increased to 15%, with BIG W performance being very positive. Mini majors increased to 6.3% MAT growth, with discount variety pharmacy and some sporting seeing increases due to more time being spent at home. And our specialty sales have recovered to 0.5%, with our core categories continuing to perform well. Strong Christmas trade with December being 10.5% up. Our nondiscretionary categories outperformed our discretionary categories. We continue to see stronger performance from our neighborhood centers versus our subregional centers. And excluding Victoria, which was primarily closed due to COVID, our specialty MAT would have been 4%. Our turnover rent growth continues to increase. We now have 39 anchors or 35% of our portfolio anchors contributing turnover rent, with a further 14 supermarkets within 10% of the turnover threshold. Two anchor tenant turnover rents were captured into base rent reviewed during the period. The specialty key metrics is outlined on Slide 17. And we are really focused on sustainable occupancy costs for sustainable specialty tenants. Our sales growth increased to 0.5%. Our sales productivity increased to $8,367 per square meter, and our rents remain one of the lowest in the sector at $788 per square meter. And our occupancy cost reduced marginally to 9.9% from 10% at June 2020. Our strategy has been to maintain a high retention rate on renewals. This is up to 78% for the 6 months to December compared to 76% through the 12 months to June 2020. We're looking to reduce our specialty vacancy with a focus on our long-term vacancies. We did 63 new deals in the 6 months to December, a strong result given the COVID-19 restriction, and we will continue to remix towards our nondiscretionary categories. Strength in the quality of new deals is reflected in a positive average leasing spread of 0.8%, in June, it was negative, and lower average incentives at 11.8 months. The average renewal spread was negative 4.6%, and this was due primarily to 3 unfavorable pharmacy renewals. Excluding these, the renewal spread would have been minus 1.9%, which is relatively consistent to the renewal spread at June 2020. And we've been able to continue to achieve our 3% to 5% annual fixed rent increases for at least 80% of the specialty tenants. Sustainability is outlined on Slide 18, and we continue to focus on our long-term sustainable performance. We've got 3 pillars to our sustainability strategy. In stronger communities, and this is our commitment to build stronger community relationships, and this was further progressed with the commencement of our partnership with The Smith Family. Environmentally efficient centers, sustainably focused investment to drive programs that generate acceptable returns with particular focus on automating our buildings, energy-efficient lightings, renewable energy and also some industry participation. And then finally, responsible investment. The next phase of our strategic planning and engagement across the business is to deliver a revitalized strategic outlook for ESG. Turning to Slide 20, which highlights the 2 acquisitions that we've spoken about previously. Bakewell in the Northern Territory was acquired in September 2020 for $33 million, representing a 7.22% implied fully let yield, and the adjoining petrol station was acquired for $6.4 million in December 2020. It is anchored by Woolworths and 11 tenancies. We also completed the acquisition of Auburn Central for $129.5 million, representing a 6% implied fully let yield. We exercised our option to acquire 10 hectares of development land adjacent to our Greenbank center in Southwestern Brisbane. And finally, in December '20 and January '21, we agreed terms to acquire Katoomba Marketplace and Cooloola Cove, which are both expected to settle in February 2021. Slide 21 highlights the fragmented ownership in our sector, and this provides us with further acquisition opportunities. We are the largest owner by number of convenience-based centers, and we'll continue to look to consolidate this sector by utilizing our funding and management capability to execute on accretive acquisition opportunities. Since listing, we have acquired 52 neighborhood centers for in excess of $1.9 billion in aggregate, and we have also divested 34 centers for over $500 million. And during the half year to 31st of December 2020, there were 10 neighborhood centers and 3 subregional centers that were transacted. However, we will continue to remain disciplined with respect to acquisitions and disposals, and we will transact where we believe that a relevant asset will add value to SCP. Slide 22 outlines our indicative development pipeline over the next 5 years. In summary, we've identified and working on more than 30 potential developments, totaling CapEx spend in excess of $100 million. Slide 23 outlines our retail funds management business. SURF 1 was successfully ended in October 2020, which produced an IRR of 11% to those unitholders. And SURF 2 is on track to end in 2021, which should provide an IRR of around 12% to the unitholders. There are no new funds forecast for FY '21. However, we will continue to monitor the retail and institutional market appetite for new product later in the year. I'd now like to talk about our key priorities and outlook on Slide 25. Our core strategy remains unchanged. We will continue to seek and deliver defensive, resilient cash flows to support secure distributions. We'll continue to focus on the convenience-based retail centers with a strong weighting to the nondiscretionary retail segment, and we will be seeking long-term leases to quality anchor tenants such as Woolworths, Coles and ALDI and Wesfarmers, which was again demonstrated by our latest acquisitions. We'll continue to explore the core business growth opportunities with our development pipeline, but we will remain disciplined with respect to acquisition and disposal opportunities that meet our future investment -- that meet our current investment criteria. I'd now like to hand over to Mark to talk about the potential future impacts of COVID-19.

Thanks, Anthony. We've included this Slide 26 to help people think about the potential impact of COVID-19 on our second half results. As we've seen in previous periods, the primary impact of COVID-19 for the rest of the financial year is expected to be the nonpayment of rent by tenants whose sales have been negatively impacted by the pandemic. You can see here that there are 3 categories of specialty tenants that have been particularly impacted over the last 12 months, being those in the apparel, services and cafes and restaurants subcategories, which together represent around 16% of our gross rental income. Interestingly, all 3 of those categories traded relatively well in November and December last year following the end of the Victorian lockdown. As we've said previously, our strategy has been to reduce our weighting to the apparel category. And you can see this again in the last 6 months with 8 apparel stores closing and only 2 new apparel stores opening. Finally, the number of tenants that we're giving rental assistance to has decreased significantly from a high of 44% in April down to below 10% in October. And this is expected to continue to reduce further once the Mandatory Code of Conduct ends in March this year. Anthony, back to you.

Thanks very much, Mark. So turning to Slide 27, our key priorities and outlook for FY '21. Love local, shop local, act local. Local centers have never been so important to the communities that they serve. Our primary objective over the next 6 months to ensure that our centers emerge from the COVID-19 pandemic in a stronger position as we get back to business as usual. Our focus continues to be serving our local communities for their everyday needs, partnering with our supermarket anchors to provide a convenient supermarket offer. This includes working with Coles and Woolworths to improve their online offer. 58 supermarkets in our portfolio now have dedicated click-and-collect bays. Two supermarkets have drive-through for online pickup with a further 7 planned for the second half of FY '21. And online sales are generally included in turnover rent calculations for the vast majority of our centers. We're actively managing our centers to ensure that we have sustainable specialty tenants paying sustainable rents and ensuring that the long-term sustainability of our business, including building those stronger communities, having more environmentally efficient centers and also the responsible investing. This all supports our strategy of generating defensive, resilient cash flows to support the secure and growing long-term distributions to our unitholders. We'll continue to explore and acquire accretive neighborhood centers in a disciplined and measured way while also progressing our identified development opportunities. We'll continue to actively manage our balance sheet to maintain diversified funding sources with long weighted average debt expiries and a low cost of capital consistent with our risk profile. Our gearing is to remain below 35% at this point in the cycle. And finally, our earnings guidance. Our FY '21 FFO per unit guidance is to achieve at least $0.144 per unit and our AFFO per unit guidance of at least $0.122 per unit assuming no further major outbreaks of COVID-19, no significant new government restrictions and no further acquisitions other than Katoomba and Cooloola Cove. Finally, our medium-term target is to return to AFFO of $0.15 per unit once the pandemic has ended and our equity raising proceeds are fully deployed. I'd now like to invite some questions. Thank you.

[Operator Instructions] Your first question comes from Andrew Dodds with Jefferies.

Just firstly, looking at specialty vacancy, it was down to 4.8% at the half. I was just curious to hear your, I guess, expectations going forward now that the insolvent trading rules have kicked back in and, I guess, with the expiry of JobKeeper and the Code of Conduct as well in late March?

Yes. Thanks, Andrew. Look, we've been pretty focused on some longer-term vacancies to get that specialty vacancy down. To date, we haven't seen any real change. We always have some specialty tenants that fall over in good times and in tougher times. Looking forward, look, JobKeeper is coming off. But the strength of our specialty sales in all the categories except for the ones that we've called out there, apparel, services and cafes and restaurants, which have had a good bounce back in both November, December and anecdotally in January, with this whole dislocation from CBDs out to the local centers, hopefully, it will be -- we won't be affected too much. There could be some fall-overs. We always will have fall-overs. But the strength of our sales and the dislocation of people down to those local centers, regional centers is a real positive for us. So we'll just see. That's why we've always focused on getting those 3 core categories of food, pharmacy and medical and services because we believe they're quite sustainable business for our types of shopping centers.

That's great. And then just switching gears -- sorry, go ahead. Sorry, switching gears just to the turnover rent side of things. We've clearly seen some pretty strong growth, increasing to $2.6 million in the half compared to just over $3 million the full year. Are you able to quantify where you expect this to land for the full year?

I'd love to be able to quantify it, but I can't. We have had -- the period last year -- these next 6 months, January to June, was some of the most volatile supermarket sales that have ever been seen in Australia for last year. And it's going to be interesting to see how those supermarkets perform against those really elevated levels. So it is really difficult to forecast. Personally, if the supermarkets were able to stay flat against last year, I think it will be an absolutely exceptional result purely because those sales last year, I think in some months, they were 20%, 30% up. We've never seen that before. So yes, it's really difficult to forecast at the moment.

Your next question comes from Simon Chan with Morgan Stanley.

So a question in relation to Slide 17. You -- the bottom bullet point, you said you're continuing to achieve 3% to 5% annual fixed increases for 80% of the specialty tenants. So I've got 2 questions in relation to that. First one, would the average be closer towards the 3% or 5%? And the second question, can you comment on the remaining 20% of specialty tenants who aren't in that 3% to 5% bucket? How are their leases structured?

Yes. Thanks, Simon. The average is pretty much in the middle, so around 4%. The -- in terms of the other 20%, as shown in the chart below, 10% of them are CPI-linked, generally CPI. And then some of the fixed increases are less than the 3% to 5% range.

Right. Is this a trend that you guys are a little bit concerned with? Because I went through the -- your previous presentation and you had a 90% -- I mean 88% of specialty tenants in the 3% to 5% fixed increases. And now you're at 80%. Should we see that trend come down to 75%, 70% going forward? Or do you think 80% is probably about the new normal?

No, look, I think 80% is about where it's at. And as you've seen over the last -- this COVID period, particularly in the first few months of the period, there were some negative spread lease deals and maybe some terms that weren't what we would normally do. But I think in general, we should be at least at these levels.

Great. Just one more for me. I just want to make sure I'm interpreting the 99% rent collection properly. I guess my question is, so how much rent or percentage of rent did you guys collect in the first half that was billed in the half?

So the rental shortfall in the first half was about $26 million. So if you look at the sort of half yearly rental income, which is roughly around $140 million, you can work out the percentage. But -- so there's a significant shortfall in the half year ended 30 June, but we've recovered that strongly in the last few months. And you can see that on Slide 7 where we went down to as low as 69% collection in April.

Yes. I was more asking about the December half, Mark. The -- how much of your December half billings in the last 6 months have actually been collected in the last 6 months?

Yes. Okay. The number is about 91%. So there was -- I'm sorry, I misunderstood your question. So there's around about a $13 million cash shortfall in relation to invoices that related to the first half of '21. But that was offset by a similar amount of collections that related to the FY '20 financial year.

Okay, okay. About 96%. That's terrific.

91%, I said. 91%. I said, 91%.

Sorry, mate.

Yes, 91%, which represents a shortfall of about $13 million for the half. But that was offset by $13 million of collections that actually related to FY '20 invoices.

Your next question comes from Edward Day with Moelis Australia.

Mark, just on that Slide 7, there's been a bit of a plateau in the collection rate at 85%, 86%. Could you just talk to exactly why that's stabilized? And I'm guessing you'd expect to see that rebound pretty quickly once the New South Wales and Victorian SME codes expire.

A lot of the reason that there's a delay in payment is that tenants who are expecting to get a credit under the Mandatory Code of Conduct are generally waiting until they've received that credit, i.e., waiver and deferral, before they pay their rent. And there is a time delay there because we can't calculate the credit that they're due until we receive their sales for the relevant month. So whereas we might invoice at the beginning of the month, and we do invoice at the beginning of the month, the sales don't become available obviously until after the end of the month. And then it takes us some time to process those requests so that you do end up obviously getting a delay in payment. And that's the main reason that we're not back to around that 90% level, which would where -- which is where we were pre-COVID.

So assuming at 1 March, there's no more code of conduct in place, that should be 91%, 92% from there on?

Yes. Look, I'd expect it to get back to that 90% level by the end of this next half. And as you say, the key timing there is that the code of conduct has ended in a number of states, but it's still continuing until the 28th of March in those big states of New South Wales, Victoria, Queensland -- Vic and WA, I should say, New South Wales, Victoria, WA. April, May, June, we should start to see that get back to 90%.