Scentre Group (SCG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Scentre Group 2023 Half Year Results Update. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, the 22nd of August 2023 at 9:00 a.m. Australian Eastern Standard Time. I would now like to hand the conference over to Mr. Elliott Rusanow. Please go ahead.

Good morning, everyone. I would like to acknowledge the Gadigal People of the Eora Nation as the traditional custodians of the land I am on this morning, recognizing that many of us are on lands of different traditional custodians, I pay my respects to each of their elders past, present and emerging. Welcome to Scentre Group's 2023 Half Year Results Briefing. I am joined today on the call by our Chief Financial Officer, Andrew Clarke, together with Lillian Fadel, Group Director of Customer, Community and Destinations; John Papagiannis, Group Director of Businesses; and Stewart White, Director of Development, Design and Construction. Our strategy is to create places that more people choose to come to more often and stay at for longer. It is based on the premise that the more time people spend at our destinations, the more opportunity and value we create for other businesses to interact with customers. And the better we are at achieving this the more earnings and distributions we will generate and continue to grow for our security holders for the long term. And the results that we have achieved for this half demonstrate this. So far this year to the end of last week, we have seen a 9.8% increase in customer visitations to 314 million. Our business partners achieved record annual sales of $27.8 billion to 30 June 2023, an increase of $4.9 billion or 21.6% compared to the same period in 2022. And business partner sales for the first 6 months of 2023 were $13.1 billion, an increase of 9.1% over last year and 13.6% more than the same period in 2019. We have generated a 10% growth in net operating income to $972 million in the first 6 months of this year, the highest level the group has ever achieved in a first half period. Our funds from operations were $556.6 million for the first half, up 1.5% over the same period last year and 13.3% higher than the second 6 months of 2022, and our distributions to security holders increased by 10% to $0.0825 per security for the 6-month period. I would like to thank our team for their contribution to executing our strategy and delivering these results. By focusing on attracting more people to our 42 Westfield destinations located throughout Australia and New Zealand, as many times as possible and for as long as possible, we created the most efficient platform for businesses to connect with more customers. Our growth in customer visitations has been driven by our unique and deliberate activation program, including our strategic partnerships with Disney and Netball Australia, together with many localized activation events, creating extraordinary experiences for our customers and our Westfield destinations. This week, we announced a new partnership with Live Nation, which will bring exclusive live and free music performances into our destinations, creating even more reasons for people to spend their time with us. As a result, we have been able to drive demand from business partners wanting to take space at our destinations and connect with customers. During this half, we completed 1,567 leasing deals and welcomed 585 new merchants, including 125 new brands to our portfolio. And we have seen this strong leasing deal activity continued since the end of June. Portfolio occupancy has increased to 99% at 30 June compared to 98.8% last year at 30 June, and we maintain our standard lease structure with fixed base rent and annual escalations, the vast majority of which are linked to inflation. On average, specialty rent escalations have grown by 8.1% and leasing spreads on new leases signed during the first half were past 2.6%. Of note, average specialty occupancy costs are now 16% of specialty sales compared to 18% in 2019. And we collected $1.332 billion in rent during the half, representing 103% of billings and $82 million more than the first half of 2022. We continue to make progress on strategic customer initiatives, particularly our Westfield membership program, which has more than 3.5 million members, an increase of 750,000 since June of last year. The group has invested $19 million in strategic customer initiatives during the period, including our membership program. Operating as a responsible and a sustainable business underpins our strategy. During the half, we released our 2022 Responsible Business Report, Modern Slavery Statement and our first Climate Statement. Progress continues on our pathway to achieve net 0 by 2030 with the recent completion of rooftop solar installations at Westfield Fountain Gate and Knox. Rooftop solar installations are also underway at Westfield Hornsby and Tuggerah to be completed by the end of this year. Together, these installations will more than double the group's solar generation capacity from 5.9 megawatts to 12.2 megawatts. Investing in our destinations to ensure they remain the places where people choose to spend their time is very important in how we will continue to achieve our strategic ambitions in the longer term. In June, we successfully opened Stage 2 of our $355 million investment at Westfield Knox, of which our share is $178 million. Visitation since Stage 2 opening is already up 13%. We look forward to opening the remainder of the center by the end of the year. Recently, we agreed to exit the Central Barangaroo Consortium and better position us to pursue our core strategic opportunities, including the $4 billion of future development pipeline opportunities. I will now hand over to Andrew Clarke to present the financials.

Thanks, Elliott, and good morning, everyone. Funds from operations for the 6-month period was $557 million or $0.1074 per security, which grew by 1.5% compared to the prior corresponding period. The interim distribution for the period is $428 million or $0.0825 per security, up 10% and in line with guidance. The strength of these results have been underpinned by our continued focus on driving more customer visits more often and for longer. The value of our standard specialty lease structure, having average annual escalations of CPI plus 2% and strong gross rental collections. Net operating income for the period was $972 million. This is an increase of 10% over the first half of 2022. This includes a $5 million release in the expected credit charge provision as a result of delivering strong cash collections. This compares to a $14.3 million charge booked in the first half of 2022. Underlying net operating income, excluding the release of the expected credit charge grew by 7.7% for the period, which was primarily driven by inflationary-linked specialty annual retail escalations of 8.1%, an increase in occupancy to 99% and 10% growth in net ancillary income, which is now in line with pre-pandemic levels. Operating and leasing capital was $76 million for the first half. During the half year, $1.3 billion or 103% of gross rent billings were collected, representing an increase of $82 million compared to the prior corresponding period. Net trade debtors after the expected credit charge provision at 30 June 2023 were $49 million. This represents a reduction of $102 million compared to 30 June 2022. During the period, the group repaid bonds of $745 million and redeemed the $162 million Westfield Southland Property Linked Note with existing bank facilities. In addition, extended and raised new banking facilities totaling $1.6 billion. As a result, the group has $3.9 billion of available liquidity, which is sufficient to cover all debt maturities until the end of 2025. The weighted average interest rate for the 6-month period was 5.5%. This consists of an average margin on total bank, bond and hybrid notes of 3% and an average base interest rate of 2.5%. Excluding the subordinated notes, the weighted average interest rate for the period was 4.6%. The group continues to actively manage its interest rate hedging position. During the period, we increased our hedge coverage to 93% at June 2023 and 89% at December 2023, both at an average fixed rate of 2.39%. The weighted average interest rate is expected to be approximately 5.6% for the full year. The statutory result was a profit of $149 million, which includes an unrealized property revaluation decrease of $393 million. All properties were revalued during the half year, of which approximately 50% being externally valued. Overall, property valuations decreased by 0.6% during the period, driven by an average 20 basis point softening of capitalization rates, partially offset by growth in net operating income. This includes the revaluation of Westfield Knox following the opening of Stage 1 and Stage 2 of the redevelopment. The weighted average capitalization rate for the portfolio was 5.13% at June 2023 compared to 4.93% at December 2022. We have provided on Slide 22 a summary of the values by property. Thank you, and I will now pass you back to Elliott for closing remarks.

Thank you, Andrew. We will continue our focus on creating destinations where people want to spend their time, enabling more brands and businesses to connect with more customers. The group is well positioned to continue to deliver long-term growth in both earnings and distributions. Subject to no material change in conditions, the group reconfirms that it expects FFO to be in the range of $0.2075 to $0.2125 per security for the full year of 2023, representing 3.4% to 5.9% growth for the year. This equates to growth in FFO for the second half of 2023 of between 5.6% and 10.9% compared to the second half of 2022. Distributions are expected to be at least $0.165 per security for 2023, representing at least 4.8% growth for the year. I will now open the call for questions. Thank you.

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

Elliott, just interested in the guidance where you're calling -- just back on the envelope, it looks as though the second half FFO is implied to be down between 2% and 7% based on what the first half results delivered. I understand you're calling the way leverage cost of debt up 10 basis points, and there was a $5 million ECC right back in the first half. But just wondering why -- what else is kind of holding that back from not being a stronger second half?

Richard, it's Andrew here. Yes. So look, the main drivers of growth in the second half, we are expecting NOI to continue to grow and to have growth in the first half of '23. We aren't assuming any further release of the expected credit charge in the second half. So that is the $5 million that was released in the first half. So that is a bit of a drag. But offsetting that growth at a macro level is really the increase in the interest expense. That's really the main driver. And the other line items, overheads would expect to be relatively flat. Project income relatively flat. We would expect the tax expense to increase slightly based on the weighting of the ancillary income that we generate. A lot of that is generated in the second half of the year, higher weighting. So there's higher tax and then we're also expecting property expenses to grow at a slightly higher rate in the second half as well.

Okay. And just to clarify, the fact that you've got billings at 103%, that's not coming through income, right? That's just the cash collection that you're talking about?

Yes, that's right. So basically, the amount of cash that we collected in the first 6 months is effectively 103% equivalent to what the billings were. And that's why our debtors have come down. So as I spoke, debtors have come down compared to this time last year by $102 million and debt is now sitting -- net debtors are sitting at $49 million.

Okay. And then, I mean, obviously, the operating metrics were really strong. Just interested what, if any, impact you're seeing from rising cost of living pressures. Can you maybe talk about whether June, July sales have shown any pullback? And any change in obviously the really strong leasing spreads that you announced today?

So it's Elliott speaking. Richard, what we have seen is, as I said, the continuation of customer visitations each week are higher, I think, throughout the -- in course of the entire year have been higher, ranging somewhere between, call it, 6% to 10% week-on-week, they do bounce around a bit. But each week this year, continuing up until the end of last week, continues that growth. So we haven't seen any pullback in customer visitations. We have seen sales for the June, July period moderate in terms of their growth rate. But bearing in mind that June and July sales in 2022, I believe, we're somewhere in the order of 13% or 14% higher than the previous year. So the other component to all of that is, as I mentioned, the level of leasing activity we're seeing has not pulled back. So more businesses are signing. They're signing long-term leases with us. I didn't say this on the call, but our average lease term has increased from 6.8 years to 6.9 years. So the level of activity that we're seeing, both from a customer visitation standpoint, from the record sales that are being generated at the center, the $27.8 billion continues and we've signed well over 300 new lease deals since the end of June. So that momentum continues.

Your next question comes from Lou Pirenc from Jarden.

Just a quick follow-up on Richard's question there on the credit charge. So the $5 million release, you booked at above the line?

Yes. So you can see that coming through in the property expenses line in the P&L that we've provided in the slide. So it comes through as a favorable movement in the property expenses line. So that's $5 million in the 6-month period, and that compares to a charge position that went through in the 6-month period to 2022 of $14.3 million.

Okay. I thought you booked all of that below the line previously, but clearly not. Just on development, can you just give an indication of kind of how you're seeing the environment to start new notes like developments and what we should really expect in terms of CapEx and returns.

Yes. Lou, it's Elliott. I think the next big project that is on our pipeline would be Booragoon in Perth. That's probably likely to start, if not late next year, probably in 2025. So what you're really seeing is the large-scale developments pull back in terms of additional new supply. I think that we're seeing the benefits of a pullback in supply generally over the last few years come through in the much stronger operating metrics that are being delivered. And so I would expect that limited supply will be added in a kind of a large scale to the lesser number of projects, such as what we've talked about with Knox, Booragoon and probably a lot more focus on investing capital to extract better returns out of real powerhouse assets that we have within the portfolio, the things like our Parramatta, Bondi. And so it's about driving efficiencies, I suppose, creating spaces for more businesses and more diverse range of businesses to interact with the customers that we're generating and keep generating growth of to come to our centers.

Your next question comes from Sholto Maconochie from Jefferies.

Congrats on a good result. Just playing on the ECC, it looks like on the margin -- thanks for the color. So you had about a $19 million benefit if you take the 14.3% and 5%. And it looks like your NOI margin went up about 100 basis points to 78.1%. Is that expected to be sort of flat for the full year or sort of moderate a bit in the second half from those higher property expenses?

Sholto, Andrew here. So you're right that there is effectively a $19 million swing between the expected credit charge in the first half of last year and the $5 million release this year. As I spoke about in our -- in my notes that the underlying NOI growth, if you exclude that is 7.7%, and a lot of that has been driven by the growth in the rental escalations of 8.1% our increase in occupancy to 99%. And we've also seen ancillary income returned to pre-pandemic levels. And so there was a 10% growth in ancillary income as well. In terms of the margin that you referred to, so we would expect them to be pretty similar in the second half, maybe slightly down just because you can see that our expense growth in the first half is relatively low.

That makes sense. And then just on the -- I think you had very strong escalator growth, especially 8.1%. What's CPI? I think the June was about 6%, should we assume a similar level of specialty rental growth in the second half?

In terms of the escalations, we are assuming that inflation does slow a bit from here in terms of -- or moderate -- sorry, in terms of growth, but still probably around the growth, 5.5% of inflation in the second half on average.

7.5% to 8% depending -- okay, all in. All right. And then just on the sales, I noticed you look up sales were up 9.1% for the 6 months, and they slowed from 14.4% from first quarter and specs were 12.1% for the 7. So what was the sort of -- do you have the number for the sales -- the second quarter '23 total sales and specialty sales? I can work it out, but do you have it at hand?

Yes. It's -- so looking at it here, it's around 4.5% with the growth in total sales for the second -- for that second 3 months.

And what was it the similar categories that others reported homewares, sort of furniture and sort of fashion and apparel that were weaker in the strategies because supermarkets broadly stable. What's the sort of drag, if you don't mind?

Well, I think, yes. So the fashion and homewares were a drag, but offsetting that is -- and we have, as you know, over time, increased our space to these categories that have grown dramatically, things like dining, health and beauty, leisure and sports, things at the consumer on site. Our premise being that we're creating places where people are spending their time and therefore, they're experiencing consumption, I suppose, of their -- of what they do when they are spending their time with us. So bearing in mind that the drag, so to speak, in what we've talked about with fashion and homeware has come off an incredibly high base that it's compared to from last year, which was -- obviously, it was about from the pandemic period.

Yes. That makes sense. And then just finally, what's the passing rate on the bonds so to look in the accounts for the expiring in '23 and '24, what you're currently paying on those?

Sholto, so on average, that would be around 2.5% plus -- 2.5% to 2.75% margins.

Broadly in line with what you -- okay. That's great.

Your next question comes from Ben Brayshaw from Barrenjoey.

I was wondering if you could just discuss your approach to the refinance of the senior bonds coming up and just how you're seeing offshore funding markets?

Ben, Andrew here. So look, one of our strategies has been to continue to have an elevated level of liquidity. So as I said, we've got $3.9 billion of liquidity. What that does is it gives us significant flexibility in terms of how we refinance those bonds. And if we decide to, we can use that liquidity effectively, you'd be swapping expensive bonds for much cheaper bank facilities, and we've done that year-to-date. But at the same time, we continue to monitor the debt markets to look at opportune times where we may look to issue new bonds, longer-term bonds as well. So we're keeping it open in terms of how we approach that and keeping flexibility for that.

And just on the timing of specialty revenues, can you just touch on how they're distributed over the course of the year and whether there is a second half skew in relation to the CPI uplift?

Yes, there's generally a slight second half skew. A lot of that comes from the -- historically of when redevelopments have opened. And you generally see a lot of our redevelopments open in the second half of the year. So then the lease anniversaries. There's a slight weighting to lease anniversaries in the second half of the year. But it's -- it would be something like 45%, 55% weighting.

Your next question comes from Grant McCasker from UBS.

Elliott and Andrew, just on the development CapEx. So I just wanted to just clarify your comments. You're basically saying that no major developments until sort of late '25. But can you sort of just outline the level of CapEx you'd be spending on the portfolio, be it major conversions, any other sort of refurbishments across the portfolio. And just as a slight extension, one of your major tenants been David Jones went through a major change of ownership. Can you provide us an update on any change in lease terms with that tenant?

Yes. So I think the -- just to clarify the comment when we're talking about major development stats. I mentioned late '24, probably sometime in '25, so not late '25 necessarily for Booragoon. The -- as Andrew guided, the run rate of maintenance and leasing CapEx is around $150 million per year. A lot of that is from a maintenance point of view, actually being spent in, call it, ambient upgrades to drive a better experience for the customer, not maintenance in its pure form sense. The CapEx, obviously, in this current half includes the spend at Knox and then smaller amounts for predevelopment work. So I think that run rate of -- now has any guess, it's $150 million plus whatever we then spend on incremental lesser, bigger project major development works. Will probably be the run around until we start the next major project at Booragoon. So with respect to David Jones, I'm not going to comment specifically on any particular group, but it's fair to say that we're working well with all the groups that are business partners. And you can see that in the operating results, our occupancy is up and we continue to look to continue to grow all the businesses that operate with us, including David Jones.

Okay. But I just want to check your cash flow from investing activities for the half is $230 million, let's annualize that, you're nearly at $500 million. You're calling out $150 million of leasing and maintenance CapEx. I'm just trying to work out where the other $200 million to $300 million is being spent.

Yes. Grant, Andrew here. So in terms of the first half year, so I spoke about operating and leasing capital is $76 million, and Elliott touched on that. We've also spent development capital. That's the active development. So we've got spend at Westfield Knox as the main active development that we have running at the moment. There's also some sundry projects. So at the moment, there have been a number of major tenants that we've been either downsized and/or replaced on occasion. So there is some capital spend there. And then there's also the predevelopment work that we continue to do, which is on that $4 billion pipeline that we talk about. So yes. And the other item that you may be referring to is the PLN. So we did redeem the Westfield Southland PLN.

I know that's in financing, but it's also looking at investing cash flows, but okay. Thanks for the clarity.

Your next question comes from James Druce from CLSA.

Elliott and Andrew, for the first question, how much development income was coming through in this first half?

Yes. So, Andrew here, James. So the amount of development income there's not a lot at this stage. We've only -- we had the first stage of Knox come through and then the second stage also open. I think from memory, it's about just under 1% of the 10% growth that we had in net operating income.

Okay. And how is that expected to -- is that expected to double in the second half or...?

It will be slightly higher than that. The remaining stages are towards the end of this year.

Okay, that's clear. As a rule of thumb, how do we think about the seasonality? I mean one of the earlier questions, you sort of touched on the buyers of leases coming through in the second half. There's also a skew to ancillary income. What's the rule of thumb that we should be thinking about on an NOI skew between first half and second half?

There's no set formula for that, James. It depends on what's happening with occupancy. It depends on what's happening with escalations. It depends on what's happening around the portfolio in terms of sundry projects. The main skew is really the escalations, and I spoke about that before. So it's slightly weighted to the second half. And the other slight weighting to the second half is ancillary income because of the seasonality of that, in particular, in Q4 with the Christmas trading period. But all the other movements, there's no seasonality to that. It depends on each individual asset and what's actually happening at the asset. So the timing of, say, a store closing versus the timing of the store opening.

Yes, the other part to that is that we have less than 1% of our income tied to turnover. And so seasonality with regards to sales is -- it doesn't skew as might be seen in other places.

Yes. Okay. One final one, if I may. If I just look at the second half revenue from last year, sort of how you put it together in your prize, that was kind of $1 million, $2 million, $3 million, $7 million. And then if I look at the first half of '23, it's also $1 million, $2 million, $3 million, $7 million. Once you take for expenses, you're talking about sort of some decent growth, but so expenses were going against you. I'm just wondering why there isn't more growth from second half last year to first half this year.

While second half last year was a strong period. You recall there was significant growth that came through in the second half of '22 compared to the first half of '22. And then we have seen growth in net operating income in the first half of '23 over the second half of '22. If you look at the amount of net operating income, there was $972 million of NOI in the first half of 2023 compared to $909 million in the second half of last year. So we would look at that as pretty good growth.

Yes. I'm looking at it on the property revenue line just above that, maybe we'll take it offline.

Your next question comes from Caleb Wheatley from Macquarie Group.

Elliott and Andrew, just following up on a couple of questions from earlier. Just on the ancillary income component of NOI, can you give us a feel for how much of that NOI line is comprised by ancillary income. And given, I guess, it's been a pretty strong recovery there, how should we be thinking about that ancillary income on a go-forward basis in second half '23 and '24 wards, please.

Caleb, Andrew here. So ancillary income, I spoke about that is 10% growth over this time last year, and it's also now in line with pre-pandemic levels. So we would expect at the rate that, that part of our business is performing that we'd expect that to continue to be strong in the second half of the year. The second part of your question around what portion of NOI it is, I think, is what you're asking. So it sits at around 9%, 9% to 10% of NOI. And in terms of 2024, look, we're not providing any guidance at this stage. But if the operating conditions continue as they are, we continue doing lots of things that we're doing to create more customer visits more often for longer, we'd expect that, that area of the business continue to grow like we expect the rest of our business.

Great. That's really helpful. And just following up on your comments around some of these potential large development projects that might come in into the future on likes of Parramatta or a Bondi. I know it's a long way off potentially. But how are you thinking about the sort of development that might be? Is that going to be just on a retail focus? Or are there other potential subsectors, i.e., offers of build to rent that might form part of that development discussion on those sorts of assets.

Well, I think I'll tell you here, sorry. The focus on those are actually what capital we should be spending to actually grow market share of those assets in terms of what people are spending their time on and their consumption dollars doing. So I think that the way to think about the incremental spend at something like a Parramatta or a Bondi or many of the assets is actually diversifying the businesses that would be interacting with customers. So more lifestyle, entertainment, health, medical, potentially education. It's not so much building more horizontal or vertical space. It's probably more about redeploying existing space in a much better way in line with what people are actually spending their time doing and spending on.

Okay. Great. That's clear. And then just a final one for me. I think 6 months ago, you mentioned potentially considering selling down interest in some of the 100% owned assets. Just wondering if there was any update on that front. It seems like the retail market, particularly is still relatively liquid at least compared to some of the other subsectors, would be keen to get an update on how you think about potential opportunities there as well, please?

Well, I think at the time, we said that and still the case that we look at potential joint venturing of assets as a funding source and the timing of which would be determined by the need for funding. So I think that, that still remains the case. And we really have nothing further to add other than highlighting the opportunity from a funding point of view is our 100% interest in 12 assets, which I think equates to some $20 billion of assets on our balance sheet.

[Operator Instructions]

Well, if there's no further questions, we thank you for your time today. And if you do have any questions, please don't hesitate to reach out to the team and follow up. And we wish you a good day. Thank you for listening. Bye.

That does conclude our conference for today. Thank you for participating. You may now disconnect.