Region Group (RGN) Earnings Call Transcript & Summary

Thank you very much for the introduction, and welcome to our half year FY '25 financial results. My name is Anthony Mellowes, and I'm the Chief Executive Officer. And presenting these results with me today is Evan Walsh, our Chief Financial Information Officer. And also in the room with me is Erica Rees, our Chief Legal and Investment Officer. Firstly, let me take you to Slide 4, which sets out our first half overview. Our funds from operation, or FFO, was $0.076 per security. Our adjusted funds from operation, or AFFO, was $0.067 per security. And our distribution was $0.067 per security. Our statutory net profit after tax was nearly $82 million. Our operational metrics remained resilient. Our portfolio occupancy remained at 98%. Our average leasing -- our average specialty leasing spreads were 2%, and our comparable nondiscretionary MAT growth remained strong at 3.2%. With respect to capital management, we have divested 4 centers for a total of $106 million during the 6 months to December '24 and have completed our initial $200 million capital recycling program. Our weighted average cap rate was stable at 6.08%. Our weighted average cost of debt stayed steady at 4.3% with 100% of our debt hedged. Our gearing is 32.8%, which is at the lower end of our targeted range of 30% to 40%. Moving to Slide 5. Region is positioned for growth, and we are looking to unlock the potential in the portfolio. The convenience-based retail sector is bolstered by supply constraints, the resilient Australian consumer and continued growing population. Our portfolio is underpinned by quality anchor tenants and nondiscretionary specialty tenants, which leads to solid comparable net operating income growth. As I mentioned, we have completed our initial capital recycling program with proceeds reinvested into acquisitions, funds management and capital expenditure and some temporary debt reduction. High levels of hedging over the next 3 years and moderating levels of inflation, together with our targeted investment center repositioning, sets the foundation for growth in earnings. On Slide 6, our strategy remains unchanged. It is to provide defensive, resilient cash flows to support those secure and growing long-term distributions to our security holders. Moving on to our operational performance, which starts with our portfolio overview on Slide 8. We have strong weighting towards the nondiscretionary food, health and retail services tenants. 46% of our gross rent is attributable to our anchor tenants, and 54% of our gross rent is to specialty and Mini Majors, heavily with a key focus on food, liquor, retail services, pharmacy and health care. We have 88 centers that are owned 100% by Region, which are geographically diversified across Australia. Slide 9 shows our leasing activity that was -- has driven higher occupancy and annual fixed rent reviews. 98% of the portfolio is occupied with 85% of expiring tenants retained. The portfolio WALE decreased by 0.2 years to 4.9 years, and our average specialty gross rent increased from $880 a square meter to $900 per square meter. And we also achieved an average of 4.2% for fixed rent reviews, which was applied across 93% of our specialty and Mini Major tenants. Moving to Slide 10. We continue to capital partner with our anchor tenants. to continue to drive sales turnover, with over 55% of supermarkets now generating turnover rent. We have 123 anchor tenants contributing 46% of our gross rent. We have 75 direct-to-boot and e-commerce facilities, and we have 2.5% supermarket comparable MAT growth to December. $4 million of turnover rent was generated from 56 anchor tenants with a further 15 tenants within 10% of that threshold. Moving to Slide 11, we continue to have consistent and resilient sales growth across those nondiscretionary tenants. Our 2% comparable MAT growth is driven by the supermarkets at 2.5%. Our discount department stores improved to 1.7%. Our Mini Majors were 2.9%. Our nondiscretionary specialties was 3.2%, and our discretionary specialty tenants was minus 4%. Our specialty sales productivity is now $10,800 a square meter, which equates to annualized growth rate of 5.8% since June 2019 prior to COVID. On Slide 12, we are proactively remixing to secure quality everyday essential tenants. We did complete 256 deals at an average leasing spread of 2.1%. Our specialty vacancy improved slightly to 4.5%. However, this could be impacted in the immediate term by the failure of a national specialty retailer. We continue to progress our sustainability targets, which are spelled out in our annual sustainability report. The key focus for us has been on environmental, which has been progressing with our social rollout and initial pilot for the battery at Chancellor Park, Queensland. And social, we continue to make a positive impact on the communities that we operate in and have maintained our 40-40-20 gender representation across senior management and Board. And with respect to governance, our alignment to ASRS is on track for that FY '27 reporting. I'd now like to hand over to Evan, who will talk through our financial performance.

Thanks, Anthony, and good morning, everyone. I'll start on Slide 15, where we highlight the key drivers of the movement in our funds from operation. Our FFO for the first half is $0.076 per security, which is in line with the first half of FY '24. There were positive contributions from the comparable portfolio NOI, which was growing by 2.4%, the impact of our transactional activity and the establishment of Metro Fund 2. The FFO growth was held back by the previously flagged short-term impact of our center repositioning projects and the normalization of our corporate-related expenses. During the half, we also raised a provision for unpaid rent relating to a national tenant that entered administration during the period. Moving to Slide 16. Our statutory profit for the half is $81.8 million. This compares to a $38 million loss in the prior corresponding half, with the impact of the fair value adjustments in our property valuations now being positive. As mentioned, our FFO was $0.076 per security. Our AFFO came in at $0.067, and our distribution for the half represented a 100% payout ratio of this amount. Our property expenses remain elevated, but in line with previous guidance, and our interest expense has now stabilized. Our maintenance capital and leasing incentives are in line with the long-run averages. On to Slide 17. As at 31 December, our total assets under management was $5.2 billion. This is an 8% increase from 30 June and includes the Metro Fund 2 properties that we started to manage during the half. Our balance sheet remains healthy with gearing of 32.8% at the lower end of our target range. This provides us with flexibility to act quickly on investment opportunities, as evidenced by our recent purchase of Kallo Town Center. Our NTA has now stabilized at $2.42 per security. The outstanding rent payable from our tenants continues to remain low at 1.4% of our billings. Slide 18 shows some further information around the change in the valuations of our portfolio. During the half, our like-for-like valuations increased by around $40 million, which represents an increase in valuations of just under 1%. Cap rates were stable with just a 1 basis point move over the half. Our discount rate is at 6.82%, which has increased by 7 basis points. We also saw $16 million of development-related capital expenditure that increased our valuations, and this is primarily related to the expansion of Delacombe Town Center. On to Slide 19, where we talk to our capital management position. It has been another busy year, busy period, where we have been focused on further improving our earnings stability over the medium term. We completed $1.4 billion of interest rate swap transactions, primarily focused on FY '26 to FY '29, where we increased hedging by an average 30% over these years. We were 100% hedged for this half and are expected to be 94% hedged for the full year. Our weighted average cost of debt remains stable at 4.3%, and we have no debt expiries until FY '27. I will now hand back to Anthony to talk through our value creation opportunities.

Thanks very much, Evan. On to Slide 21, our initial $200 million capital recycling program is complete. However, we are monitoring future divestment opportunities. That $196 million of lower-yielding noncore properties have been divested at an average passing yield of 5.3%. And we have redeployed this capital into accretive opportunities through the acquisition of Cooleman Court and Kallo Town Center at a 6.6% initial yield and also our co-investment in the Metro Fund. Additional proceeds have been reinvested into our regen, revive and solar projects. And the balance has been used to repay some debt. With respect to Slide 22, our portfolio composition approach, we are -- we continue to be focused on improving the quality of our core portfolio. We have settled on the acquisition of Kallo Town Center, and we recently exchanged on the disposal of our Target shopping center at Warrnambool. The market continues to be liquid with cap rates appearing to have stabilized, and we continue to see solid interest in this asset class. We remain the largest owner of convenience-based centers with a proven transactional track record in acquiring and disposing these shopping centers. Slide 23, our funds management platform. During the period, we established Metro 2, which grew our funds under management to $680 million, and we do believe there are additional investment opportunities with our joint venture partner there. On Slide 24, capital expenditure and unlocking the value through this targeted reinvestment. Slide 24 highlights the year-to-date and indicative spend on our capital deployment program. In FY '25, we are planning to spend around $80 million, and we are targeting a completion yield of between 6% and 10% and a 10-year IRR that is greater than our weighted average cost of capital. Although this spend is predicted to enhance future returns, we expect that there will be a short-term impact to some of these earnings. On to Slide 25, our Delacombe Town Center. That has progressed well and with key tenants now open and trading. This includes a Woolworths mini distribution center for home delivery in the Greater Ballarat area, Supercheap Auto, Rebel, Boating Camping and Fishing and a new very large Planet Fitness gym. We do have further rights on Stage 3, which will include a new Coles Supermarket. On Slide 26 is our investments in our regen and revive center repositioning projects. We have several projects currently underway, focusing on remixing tenants, improving the customer experience, improving the amenities, all to drive greater asset value. Moving on to Slide 28, our outlook. There are Australian supply-demand fundamentals in the retail sector that do benefit Region. The outlook for retail floor space remains limited, and the current merger reform and ACCC inquiries into supermarkets could also negatively impact the development of new space. There is a return of positive retail sentiment. There is a stabilization of cap rates with continued income growth, providing support for growing valuations. Evan, can you just talk through our medium-term AFFO growth target?

So to drive our medium- to long-term earnings growth, we are focused on generating comparable NOI growth of at least 3%. Through our value creation initiatives, we aim to add another 1% to our growth rate. Our work in the capital management space to increase our hedging has mitigated some of the short- to medium-term earnings volatility generated from interest rates with a longer-term impact dependent on market movements. Based on all of this, we are targeting medium- to long-term growth in our FFO and AFFO of at least 3% to 4%. I'll now pass to Anthony, who will talk through our key priorities and outlook.

Thanks very much. We do believe that nondiscretionary retail will continue to be resilient, and we will generate comp NOI growth with some moderating expenses outlook. We have some limited interest rate headwinds with our relatively high hedging in place now until FY '28. Our balance sheet is supported with stabilized valuations, which provides us the opportunity to invest in our centers, be disciplined with acquisitions and disposals and explore future funds management growth. Assuming there are no significant changes in market conditions, our FY '25 guidance is maintained for FFO of $0.155 per security and AFFO of $0.137 per security. I'd now like to hand over to any questions.

[Operator Instructions] Your first question today comes from Lou Pirenc from Jarden.

A few questions. First of all, your guidance unchanged implies quite a swing from the first half to the second half. Is it just that cost inflation you were talking about, Evan? Or are there other moving parts that we should be aware of?

Look, the second half NOI is stronger, and there's a couple of moving parts there. It's not just one thing. On the revenue side, we are seeing the impact of the higher fixed rent reviews. We are seeing increased turnover rent, and we're also expecting stronger casual mall leasing income. On the expense side, we're now seeing the impact of the technology project that we largely finished in June. We're seeing some efficiencies on the expenses related to that. And we also are starting to see a full-period impact from the solar that we've installed.

So from the second half, should we expect property income to grow ahead of property expenses? Or you think that property expenses still have a drag for a bit longer?

I think -- Lou, it's Anthony here. I think there will continue to be a slight drag, but it's moderating.

Great. And then finally, just with the industrial relations issues with Woolies in your portfolio, have you seen cause materially outperform Woolies over the period?

No. It's -- look, it's been close. It's not like there has been over many years where one is dramatically outperforming the other. It is pretty close where they're both trading. There's no significant difference in our portfolio.

Your next question comes from Simon Chan from Morgan Stanley.

I just want to dig into the 6.7% uplift in property-level expense a little bit more. Anthony, you said it will kind of moderate, but still be a drag in the second half. Like, what's the reason for the uplift? Because I thought like the -- like last year, the property-level expense was up 6.5%. First half of this year, it's up even worse. Like is there an underlying issue here we need to be mindful of?

Look, I think we did flag last year that the expenses will remain elevated. And certainly, that's been skewed to the first half. There actually is a broad [ brush ] increase across the board. There's not one particular area that is driving that. I will say, though, there has been an investment in some of the areas that will drive future growth. And I'll call out one in particular, is we have invested in sort of staff around [ casual ] mall leasing, and we are seeing that revenue growth in the second half.

Okay. Cool. That makes sense. My second question, Slide 12, leasing spreads, it seems a little bit counterintuitive or counter trend. Like spreads for renewing tenants are rather low at just 1.7% and quite high actually for new merchants at 2.8%. I thought typically, it's the other way around, isn't it, where average uplift for new leases are a bit smaller. What's going on here?

No, you're entirely right. That's what the expectation is. We did roughly 150 deals, roughly 50 were new deals, 100 deals were renewals. Of those 100 renewals, if we take 4 out, we had 4 bad ones that basically the remaining 96 were roughly in line 3% to 4%. So there were 4 that dragged it down. And on new leases, we had very 1 strong new lease that basically pushed that number up, skewed it. So it's pretty well in line, but they're the numbers that came out, but it was skewed by 5 deals out of [ 158 ].

Just one last one. You guys took $1 million or so provision for the national retail administration. Are there any longer-term impacts going forward from here into the second half of FY '26 in terms of vacancy or those stores vacating, et cetera?

Yes, there will be, and that is baked into our guidance. So we had 32 tenancies. We've actively had deals on roughly 16 of those, and there's 16 that we're working on. There is -- we are forecasting some downtime on a few of them, and we haven't received notices from the administrator yet. But we've read in the paper that they're talking about everything being closed by April, and that's pretty well what we're forecasting. So we've re-leased some straight away. Others we're holding for our regen program, and then there's basically half that we've still got to lease. Overall, we believe the rental on those -- that space will increase by sort of a 20-odd percent uplift, maybe more. However, there's some leasing CapEx, everything -- value-wise, we're going to be slightly ahead, but there's going to be a bit of a short-term issue -- short-term cash flow issue. But that is baked into our guidance at the moment.

Sorry, just to make sure I heard you clear. So you're predicting 20% leasing spreads for those stores. Is that what you said?

We think overall, out of those 32 tenants, overall, we should get an uplift of roughly 20%. They're on pretty low rents, is the other way of saying it.

Your next question comes from Howard Penny from Citi.

So just on the Mosaic administration, just talking about the -- could you provide any color on what you expect with existing rental levels of that space if it's needed to be replaced and the expectation of bringing in a new tenant into that space? Would you expect that to be higher rental levels than existing?

Yes, that's what I was just talking about, Howard. We think overall in the entire 32 tenancies that we'll get roughly a 20% uplift on their previous rent to the new market rent, so to speak. And that's going to cost us a bit in leasing capital to do it with new leases, obviously. So there is a short-term cash flow impact. But overall, we think valuation-wise, it will be a slight positive.

And what are the ideas that you would use in the space? Who would you be targeting? I know you can't necessarily name them exactly, but what would you be targeting there?

It's on a site-by-site basis, but basically, our core groups of tenants that we like, which is food, retail services, pharmacy and medical. Those types of tenants are certainly our #1 target. And then we'll go into -- in some of the other -- some of our centers that have -- that are smaller subregionals that have an apparel range, we'll be looking to modernize that apparel, and that's a big part of those regen projects that I spoke about.

Just talking a little bit about where you are on acquisitions versus your cost of capital, what kind of yields would you be looking at to buy new assets at the moment?

Yes, we've been pretty consistent over the last sort of 12 months on that. We need to get -- have an asset that has at least a 6% yield in front of it, probably a little bit more, and that's demonstrated by the assets that we bought with Cooleman Court and Kallo, which have been 6.5-plus percent. And then it has growth of at least 2% to 3% on top of that.

Your next question comes from [ Mark Murray Cullinan ] from [ Wells ] Australia.

[Audio Gap] retailer again. I was just wondering whether you could give us just a little bit more color on the downtime that you're expecting around that space. You said that everything is to be closed by April. But how long do you think it takes to refill that space and get it productive again? Or I guess, how far into FY '26, would you expect that space to be producing again on average?

Look, it's going to be -- I'd love to say we'll have deals done on everything by the end of this calendar year. But that's -- that would be a great effort if we're able to do that. There's some tougher spaces there for us. But the fortunate thing is they're not super high paying rents for us. But it is going to be a slight drag for us, but it's pretty inconsequential in the greater scheme of everything that we do.

And then again, I know we've discussed it already, but just drilling into the leasing spreads down a touch there. I was wondering to what extent we should be looking at that as sort of reflective of where we are in the cycle at the moment and tenant confidence around business prospects versus a few sort of outliers around what was actually being done.

Yes. Look, I'd say just generally on the leasing market, we are still targeting for our renewals that 3% to 4%. I don't think anything has changed there, and the vast majority were actually in that range. We had a couple that dragged us down. So renewals, I'm still comfortable on. New leases, pretty much the same, pretty well flat, although we did get a bit of an uplift this time, but there was one particular deal. The thing that has changed in the leasing market is fit-outs are a bit more expensive. You've seen our fit-out contributions. It's still around that 12 months for a 5-year deal. It's edged up a little bit to 13 months for a 5-year deal for us. That's a bit of the mix. But from my leasing executives, they are saying it is costing a little bit more for fit-outs, and that's sort of flowing through in what some of the tenants want in that ask of the negotiation on new leases. But renewals, I'm still pretty confident. And the other thing that we are still very positive on is our fixed rent reviews. We are getting closer to 5% on those as opposed to 4%. And that's why we've moved from sort of 3.8% average fixed rent reviews through the period up to sort of 4.2%, 4.3% at the moment. So they're the major changes in the market. I'd say fit-out expenses driving through to a bit more in fit-out costs, but it's moving -- still -- we were slightly under 12 months, but it's now slightly over 12 months, is what I'd say.

And then just lastly, you mentioned the additional opportunities that you're hoping to do within the funds management platform and your partner there. Just obviously, you're looking to grow that platform over time. But I was curious to hear what the sort of near-term appetite is as far as you can tell.

Look, I think when opportunities come up, we put them to our partner. And -- but I think they're on -- they like retail, they like convenience-based retail. I think there are some opportunities there that fit their hurdles and -- or that meet their hurdles. And yes, we've got to find them, and I think we will.

[Operator Instructions] Your next question comes from Richard Jones from JPMorgan.

Just in relation to the balance sheet position, do you think you'll be -- obviously, you've announced Kallo acquisition, but do you think you'll be a net buyer in 2025? And do you think you'll push gearing back to the mid-30s? I'm just conscious that you've got a few headwinds on the interest hedging side in FY '26. So just interested in how you think about absorbing that.

Look, I'll say this. We -- in the 13 years -- just seems like yesterday. But in the 13 years I've been doing this, our gearing range's being between 30% and 40% with a preference to be between 30% and 35%. We've been over 35% once in 13 years, and we've been below 30% twice or maybe 3 times. We're really happy in that range. We have bought a couple of assets worth $140 million, which is basically being funded from $200 million of divestments. We have a lot of assets that I think we've demonstrated if we can sell at 5%, 5.25% that don't have a lot of growth, but are very secure assets; we will continue to recycle that into other assets that are slightly higher yielding and have better growth, as demonstrated by Kallo and Cooleman. So I think there's -- probably that's where we're going to go. We don't like having our gearing pushed really high, as demonstrated by what I said at the start. So the flip -- the other side is, I think cap rates have stabilized. We do have good income growth. So we're not looking at there's going to be all of our assets being devalued. I think they're going to continue to increase in value. So that assists with our gearing. But yes, we're very mindful of it, but I don't think we're going to change horses and start pushing gearing above 35% in the short to medium term at all.

Your next question comes from Cody Shield from UBS.

Just a few questions on center repositioning. So if you look at '25 guidance, you included an impact from repositioning there. Just looking at first half '25, was that drag maybe a little bit heavier than you're expecting? You've got a bit of CapEx left there for the second half. So just keen to get a read on how we should be thinking about lost rent in the second half '25.

No, it's in line with what we expected. Some of the developments are pushed out a couple of months, but not -- I don't think the income is any different than what we expected. The first 3 deals are expected to be -- sorry, the first 3 projects expected to be completed by June, and the leasing will come on after that. But yes, it wasn't any different to guidance.

Okay, sure. And just kind of looking a little bit further out, you've got $48 million there committed for '26. Just kind of trying to think through, to what extent do you think the ongoing center repositioning activity is going to impact growth over the next few years?

Look, from FY '26 onwards, we're not expecting any impact. So we had a one-off negative hit for the centers we're doing this year. We expect that rent will come on next year, and you'll have some rent coming off for those new projects. So you're going to have that impact for a couple of years.

[Operator Instructions] Your next question comes from Ben Brayshaw from Barrenjoey.

I was wondering, just a follow-up question on the center repositioning CapEx, could you just provide a little bit more color or discuss the key projects that comprise the $35 million for this financial year?

Yes. They're mostly what we call our regen projects, which are predominantly our subregional centers, where roughly half of the CapEx that we spend is towards tenant incentives, where we are remixing significantly the centers and moving out older tenants and putting in newer, more appropriate tenants for that particular market. The other half of the money is spent on amenity upgrades, mall upgrades because of the age of the shopping centers, is up to sort of 15-odd years in some -- most of those cases. So they're the 2 major buckets that we spend on those, which is, like I said, leasing incentives because we're doing a lot of remixing, and center amenity upgrades and that type of stuff. And some solar is also thrown into that as well.

And so across how many projects, Anthony, would you be typically looking to include in that over this financial year?

So we've got 3 of the regen projects at the moment, so that we started last year. And we've got another 2 that are coming online and they're 2 subregionals, and we probably expect to have 2 to 3 each year to start.

For the next few years.

And when you talk about a target yield on cost of 6% to 10%, does that assume a yield on cost for the center repositioning CapEx? Or is that excluded from that target return?

No, it's included. We expect a yield on cost on that.

So sorry, to [ half ] on this, can I just clarify, is that an incremental yield on the cost? Or is that a yield that you notionally ascribe to those projects when compared with not having undertaken the work?

It's the incremental yield on the cost that we're spending..

As there are no further questions at this time, I'll now hand back to Mr. Mellowes for any closing remarks.

Well, thank you very much, everyone. I hope you got a bit out of that. Looking forward to seeing you all over the next couple of weeks as we do our road shows. And look forward to having lots of questions and discussions with you. Thank you very much, and I hope you all have a terrific day. Goodbye.