Scentre Group (SCG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Scentre Group 2020 Full Year Results Update. [Operator Instructions] Please note that the conference is being recorded today, Wednesday, the 24th of February 2021 at 9:00 a.m. Australian Eastern Daylight Savings Time. I would now like to hand the conference over to your host today, Mr. Peter Allen. Thank you. Sir, please go ahead.

Thank you, and good morning, everyone. Welcome to Scentre Group's full year results briefing. I'm joined today on the call by our Chief Financial Officer, Elliott Rusanow. As we all know, the restrictions imposed by government to address COVID-19 during 2020 made for an unprecedented operating environment. Notwithstanding this, it also highlighted how important our centers are to our customers and their communities. All our centers remained open, operational and essential, providing the goods and services and experiences our customers wanted and needed. Despite the limitations on people movement and the restrictions imposed on certain categories, such as gyms, cinemas and dining, we had more than 450 million customer visits in 2020, including an average of 46 million per month for the last quarter. Those customers spent over $22 billion with our partners and enjoyed close to 1.5 hours of their time with us each visit. I'm proud about, particularly how we kept adapting to the conditions, keeping our centers safe for the communities we serve. I would like to thank them all for their contribution to these results. It was important to note that we were proactive and deliberate in the decisions we made, with a view not just to the short term, but more importantly, the long-term ramifications of those decisions. Our capital management actions throughout the year were focused on strengthening our financial position and preserving value for the long term while not raising equity from our securityholders. We, in effect, refinanced the whole business in 2020, and Elliott will speak more about this shortly. We led the industry in the development of a voluntary Code of Conduct targeted at small to medium-sized businesses to do what was fair for mum-and-dad retailers. It was later mandated and regulated in the states and territories. To continue to provide what the customer wants, it was important for us to provide support to those SME retailers, whose business was substantially impacted due to the COVID restrictions and who didn't have access to further capital sources. It was just as important to ensure that those who had the ability to pay did just that. The cost to our business in the industry as a whole has been substantial. In fact, the shopping center industry is unique in the financial support provided to another industry. During the year, we agreed arrangements with 3,398 of our 3,600 retail partners, including 2,456 SME retailers, which were Code-related. We did this without receiving financial support in the form of JobKeeper from either the Australian or New Zealand governments. We continue to pay all our suppliers on 30-day terms to ensure their cash flow, consistent with our commitment to the Australian supplier payment code. Our purpose has held firm since Scentre Group was established almost 7 years ago, creating extraordinary places, connecting and enriching communities. Our strategic objective, our plan, is that we will create the places more people choose to come more often for longer. Approximately 20 million people live within close proximity to our 42 Westfield Living Centres. We are local to our customers and located in the heart of their communities. Notwithstanding the turbulence during 2020, we continued to evolve the Westfield ecosystem, creating new opportunities for interaction between Scentre Group, our customers and our retail partners and brands. After the successful launch of our membership program in Newmarket in 2019, we launched Westfield Plus in Australia last July. Membership continues to grow, and Westfield Plus now has more than 1.2 million members, providing an opportunity to enhance our customer engagement. We also tried an aggregated click-and-collect and connected our retail partners with customers during periods of government restrictions. The learnings from this form the basis of our strategic initiatives we are currently pursuing. As a result, demand for space across our Westfield Living Centres remains strong, with the portfolio 98.5% leased. Throughout the year, in addition to the COVID-related arrangements, the group completed 2,625 lease deals, including 848 new leases. 217 new retail brands to Westfield across all categories were introduced in 2020. Importantly, the structure of our leases has not changed and remains based on the mutual agreement to pay a fixed base rent. We saw an increase in leasing momentum in the second half with over 2,000 leasing deals. The year finished with more new lease deals being agreed in the last quarter than in the last quarter of 2019. This is a testament to the location and quality of our platform and highlights the important role stores played for retailers. During the year, we completed projects were underway at Westfield Doncaster in Melbourne, delivering a rooftop dining precinct with 14 new restaurants. We also completed a project in Westfield Belconnen in Canberra, Westfield Hornsby in Sydney and Westfield Carindale in Brisbane. In December, it was announced we were appointed by Cbus Property to design and construct the residential and commercial tower on the site of the former David Jones Menswear store on the corner of Market and Castlereagh streets in Sydney's CBD. The group continues to implement initiatives that support our strategy to operate as a responsible, sustainable business. We announced our target to achieve net 0 carbon emissions by 2030, and we have committed to the Task Force for Climate-related Financial Disclosures, or TCFD, and our 2020 annual report released today includes additional disclosure on this. We continued our Westfield Local Heroes community grants and recognition program, donating $1.3 million to recipients in 2020. Our employee engagement and retention has remained high, and we've retained and improved our external gender-equality ratings. Our 2020 Responsible Business Report and our first Modern Slavery Statement will be released on the 31st of March. I will now hand over to Elliott to take you through the financial results.

Thank you, Peter. Operating profit for 2020, which is funds from operations before project income, was $763 million or $0.1471 per security. For the second half of 2020, operating profit was $403 million, an increase of 11.6% over the first half. Funds from operations for the 12-month period was $766 million or $0.1476 per security. In total, the group achieved gross operating cash inflows of $2.357 billion. Net operating cash flow after interest overheads and tax grew by 95.7% in the second half compared to the first half, resulting in a net operating cash flow surplus for the year of $771 million. The group announced a distribution of $363 million or $0.07 per security for the second half of 2020. As a result, the group has retained approximately $408 million, which is being used to fund operating and leasing capital of $94 million during 2020 and reduce net debt. Included as an expense is an expected credit charge of $304 million year, relating to the financial impact of the COVID-19 pandemic on rental income. The expected credit charge was $232 million for the first half and $72 million for the second half of the year. The expected credit charge has been based on the commercial arrangements reached with almost 3,400 of our retail partners, representing 94% of those retail partners. The charge has also have regard to the level of cash collections we have received during the year, and particularly the second half. COVID-19 has also impacted other revenue items, such as car park revenue, ancillary income and property management fees by approximately $50 million. Our earnings have also been impacted by the slight reduction in occupancy from 99.3% at 31 December of 2019 to 98.5% at 31 December 2020 and the flow-through of the 2,625 standard, long-term leasing agreements completed during the year. Leasing spreads on these deals were negative 13.1%. None of these items are included in the expected credit charge. It is worth noting that our portfolio occupancy level of 98.5% does not include any short-term casual leasing arrangements. Trade debtors, after the expected credit charge provision at 31 December, are $193 million, an increase of $12 million from 30 June. Of this amount, approximately $45 million has already been collected in early 2021. As detailed on Slide 11, our rental collection levels have grown throughout the year and in the fourth quarter were equivalent to 100% of billings. For the year, gross cash rental collections were $2.1 billion. These collection rates, noted on that page, are prior to any COVID-related short-term rental adjustments, including the application of the SME Code. In 2021, we have continued to collect a high level of our gross rental billings, with approximately $400 million collected so far this year. Overhead for 2020 was $77.2 million compared to $88.1 million of 2010, reflecting overhead savings and efficiencies, partially offset by investments we have made into strategic initiatives. Our capital management actions were focused on obtaining additional funding in order to strengthen our financial position and at the same time, preserve long-term securityholder value. During the year, we issued and extended in total $10.1 billion of funding, including negotiating $3.6 billion of bank facilities, issuing $2.4 billion of long-term bonds and issuing $4.1 billion of subordinated notes. The group currently has $6.9 billion of available liquidity, which is sufficient to cover all our debt maturities through to early 2024. We currently hold $2.2 billion of cash on short-term deposits. We expect to use these cash funds to repay debt maturities, including the $1 billion of bonds that mature in 2021. The average net interest cost was approximately 4.4% for the year, and this has been impacted by the amount of cash we hold on deposits. Our interest expense for 2020 includes costs associated with our funding activity during the year of approximately $30 million. During the period, the group had an average hedging of our interest rate exposure of approximately 80%. Following the issuance of the subordinated notes, the group terminated $2 billion of interest rate hedges with an upfront cash outflow of $204 million. The group's level of hedging reduced to 71% after the termination of those interest rate hedges at the end of the year. We retain our A, or equivalent credit ratings, from S&P, Fitch and Moody's. The statutory result was a loss of $3.7 billion, which includes the unrealized noncash reduction in property valuations of $4.254 billion. Property valuations reduced by $151.9 million or 0.3% during the second half of the year. All properties were externally valued during year. The average capitalization rate increased from 4.72% to 4.89% over the 12-month period. We have provided on Slide 26 the detail of each property's value at the year-end. For 2021 and subject to no material changing conditions, the group expects to distribute at least $0.14 per security. We expect to be in a position to continue to grow distributions in future years. We plan to retain earnings to cover operating and leasing capital, fund strategic initiatives and reduce net debt. I'll now hand back to Peter to conclude.

Thanks, Elliott. Looking towards 2021, we know our business fundamentals are strong. Our Westfield brand is important to our customers and the community. We operate a business that is unparalleled in terms of scale and proximity to where people live and work. Scentre Group is well positioned to deliver long-term growth for securityholders. I'll now open up the call for questions.

[Operator Instructions] Your first question comes from the line of Simon Chan from Morgan Stanley.

Just first question in relation to the dividend, Elliott. $0.14, very good of you guys to give guidance 12 months out. Just wondering, how did you guys arrive at the $0.14? Is it based on a payout ratio of your internal FFO forecast? Is it based on a yield, dividend yield based on the share price at a certain date? Can you just let us know how that policy came about?

Yes. Thanks, Simon. So the $0.14 is effectively -- you'll note that we paid $0.07 relating to the second half of 2020. And we expect to be in a position to pay, in effect, an annualized amount equivalent to that $0.07 for 2021, assuming no material changes of conditions. You'll note that our FFO was obviously below -- sorry, above that distribution amount, so we have retained cash, which I mentioned on the call. And we are looking at, in the future, growing that dividend -- our distribution, I'm sorry, probably in line with the growth of operating earnings, which will now create a much larger amount of retained earnings in future periods.

Okay. So growth in line with operating earnings. Okay, fair enough. The next question, just on your revals. Looking through the details, it looks like the WA assets actually got marked up in the last 6 months, Bondi as well, Sydney City as well, which is quite pleasing. Can you give us some insights into what caused those uplift? Is it simply a removal of a COVID allowance? And should we see more uplifts going forward, if that's the case?

I think if you look at the valuations, they have, in effect, been quite -- there's been quite a minimal movement, 0.3%, in the second half of the year. Obviously, we're not going to make a prediction of what it looks like in the future. But it probably gives an indication of that momentum from the first half, which is, by and large, where all the property revaluations in terms of movement have occurred through to the second half.

Yes. And I think, Simon, what you're seeing is the stabilization of projects like Carousel up in Western Australia. I think also we had Bondi and Westfield Sydney externally valued in December. And in effect, I think what the external valuers are probably a little bit less conservative than where we were back in June at the time when we had a lot more uncertainty.

Great. And just the last one for me this morning. Elliott, I think you mentioned about $94 million for leasing and operating capital for the year and the rest of the cash to reduce net debt. That $94 million is probably a good guide as to annual cash outflow for that bucket, is that right?

Yes. I think 2020 probably was at a slightly reduced level than what other years have been, which I think historically have been around $110 million. So in a normal course, I think it probably would revert back to that circa $110 million that we've seen in previous years.

Your next question from the line of Ian Randall from Goldman Sachs.

Just on the liquidity. You're sitting at now $6.9 billion, obviously, over $2 billion of cash. I know you made the comment, Elliott, that you will be using about $1 billion to repay bonds. But do you see yourself sitting on that much liquidity going forward just given that we're, obviously, in an environment of hopefully increased certainty now?

I suppose the answer has to be how the environment evolves. Obviously, we acted very quickly at the start of the pandemic to increase our liquidity, which we did throughout year. We have $1 billion of bonds, which I noted are maturing in 2021. We have another $1.5 billion maturing in 2022. Look, I think we have to wait and see how the environment evolves. We are holding additional liquidity, but that's the setting that we've put in place because of the environment. We have operated at lower levels of liquidity in different environments. And we, I suppose, just have to wait and see what occurs in the economies to make a determination of what's the appropriate level of liquidity to hold.

Okay. And just checking the $30 million of cost that you [indiscernible] associated with funding activity. Are you just talking about incremental interest costs? Or were there some one-off upfront costs that were also booked in that expense line?

That's the upfront, effectively, the issuance costs.

Your next question comes from the line of Richard Jones from JPMorgan.

Just in relation to the expected credit charge split between the first half and the second half. Can you clarify whether there was any reversion of the $232 million in the second half that understated the second half number of $72 million? Or are they clean numbers?

They're clean numbers. I suppose the way an expected credit charge is actually applied is, because it's in the form of a provision, there's not really a reversal from one period to the other within the same 12-month period. So in effect, you're really looking at the 12-month result. There's an adjustment made in the second half, obviously, in line with the commercial arrangements that we've obviously progressed more substantially through in the second half of the year, which guides us to that $304 million in totality.

Yes. I understand. I was just trying to gather whether the $232 million was perhaps over conservative in the first half. I mean, obviously, $304 million is the number for the year. I don't know whether you've got any comment on that.

Yes, basically, it's based on the commercial arrangements that we've concluded with 94% of our retail partners, and $304 million is the best number that we have provided for.

Okay. And then just in terms of the car parking and ancillary income. Can you talk about what your thoughts are about how that might revert?

Richard, it's Peter. In terms of the car park income, what we've seen is that we had a number of car parks which we opened up and didn't charge for, particularly due to the depths of the pandemic in the first half of this year. So that had a substantial impact, and we've come back in terms of having paid parking. I think the driver of that, though, is we're still seeing also our customer visitations was $450 million -- 50 million visitations for the year, which is a little bit less than what we had last year. So we would anticipate that, that will continue to grow, particularly as consumer confidence increases with the rollout of the vaccine. So our anticipation is that both our ancillary income, both from car parks as well as media and marketing, will improve in 2021.

Okay. And do you have a first half-second half split on the $50 million drag that you called out?

Yes, it's about even. I think I did actually mention it at the first half call, what that impact was. And from memory, it was $30 million, I think, I said on that call.

Okay. And then last one. Just in terms of spreads. Can you discuss how COVID, obviously, impacted that number? Or do you think that's kind of where rents are versus market at this stage?

Well, I think that we kind of separate out in terms of the impact of COVID, which is in the expected credit charge. What we are still seeing, as I said, is strong demand by retailers for our space, given the proximity our centers are to some 20 million Australians and New Zealanders. We're seeing that, that, I suppose, negative leasing spread has come about because of the growth that we've seen historically in rents, being either 5% Victoria, CPI plus 2 in the other states. There has been a mark-to-market adjustment with regards to that. We're certainly seeing that our retailers are continuing to take roughly 5-year leases. Our standard terms are in place. We are not having any percentage rent-type deals. We're having a fixed base rent. And so to me, it is what it is. And I think that what we're seeing -- again, we've talked about this previously, Richard, is the fact that we're comparing apples and oranges in some respects because we've got different usages, we've got different types of retailers and different centers in terms of comparing that negative re-leasing spread. So -- but it is what it's going to be. And what we try and do, though, is maximize the rent that we are able to achieve from our properties. And we're doing that in a way because of the great location our centers are in, the quality of our portfolio, the overall platform we've got in terms of the scale in Australia and New Zealand but also the fact that we're certainly seeing that retailers are seeing a much improved reason to have physical stores because it's part of their overall ecosystem. And one of the things that -- if you look at the retailers' results recently, a lot of their focus is on click and collect in terms of the improvements that they're seeing in terms of their online business at times when they've had to close their stores because of government regulations. And so we're still seeing that the physical store is an important part of the retailers' ecosystem.

Your next question comes from the line of Sholto Maconochie from Jefferies Sydney.

Just a few follow-ups. Just on the ECC. Could you give a split between what was waived in the period and what was provisioned as a credit loss on that number?

Yes. Our expectation will be that, that will be the charge. So it's effectively -- you could consider it abated. It's -- as I said, it's based on arrangements, which are being documented and, yes, formally agreed. And so yes, over time, that will actually end up being effectively waived.

So the $72 million is just what's been agreed as just being waived for the period. And then going forward, you've done a lot of your -- I think 94% you said. What do you expect this period? Obviously, Code of Conduct finishes, I think, in 31 March for most states. What do you expect that charge to -- expecting it to be half of that in this period given you've only got a 3-month impact? Or can you sort of elaborate on expectations in '21?

I think it's probably too early to give any expectation, but it will be -- obviously, our expectation would be that substantially less than what it has been, even in the second half. It only applies really to SMEs. And also bear in mind that given that it's related to turnover, what we have seen in this current environment is that retailer turnover over a period has actually been quite strong, notwithstanding that there are small pockets of shutdowns for limited duration. So it needs to be probably assessed in a more total, holistic sense, which is the way the code operates.

All right. And then just on the cost of debt. I think you said it was 4.4% for the full year. That includes the cost of the hybrids in that number?

Yes.

And what are you expecting cost of debt this period? Have you broken the swaps for the hedges? Did you get a benefit this period? What's the all-in cost of debt that you expect for this period, in '21?

Yes, I think we will get a benefit, as you correctly pointed out, and it's probably going to be in the range of around 4%, maybe slightly below.

That includes the higher cost hybrids [indiscernible]

Yes, including the hybrids -- I'm sorry, that was excluding the hybrids, including the hybrids will probably be in that mid-4% range.

Okay. All right. And then just on the spread. Do you have a number for that were new versus existing leases?

Sholto, they were pretty similar. They were pretty similar.

Okay. It seems to be consistent with our peers. And then just finally, the expectation, I think it was touched on before on the spreads. Obviously, there could be sort of COVID sort of deals in that number. Some peers are saying spreads will improve this period. Do you expect that number to turn less negative in '21 as you sort of come with these higher sales that retailers are generally printing?

Sorry, as I said, we're trying to maximize in terms of the rent for our securityholders. But it's going to be what it's going to be. I think it's very difficult to predict. It's also very difficult in terms of which stores are going to be -- in fact, we're going to be re-leasing in terms of -- we're certainly seeing a great proportion of our retailers extend their leases. I think it was over 70% this year who renewed rather than bringing in new retailers which, again, is a positive sign for, in effect, cash flow for the business.

And then just on the distribution. This period, obviously, the second half was a lot stronger. I think it was about 71% payout of free cash, is, obviously, you're retaining a bit this period. So once it starts growing, do you expect to pay out 100% of the surplus free cash flow going forward once things stabilize? Or will it always be below that number? Is there a target range you're targeting of net operating surplus cash flow to pay out?