Spear Reit Limited (SEA) Earnings Call Transcript & Summary

Good morning, and thank you for joining Spear's Half Year '23 Preclose Presentation. It certainly feels like the first 6 months of the year have flown by in the blink of an eye. My name is Quintin Rossi. I'm the CEO of Spear REIT and have the privilege of leading the formidable team. To date, Spear remains the only regionally focused REIT listed on the JSE. We believe that proximity to our assets and our tenants remains a key strategic objective of our business. Spear obtained its specialization through solely investing into real estate assets within the Western Cape, and we obtained our diversification through investing into high-quality industrial, commercial, retail, mixed-use and hospitality assets within the Western Cape. The first 6 months of the year have largely trended in line with management's forecast. Pressures have been felt from the impacts of inflation, load shedding and the recent interest rate hikes. The preclose presentation today will firmly echo the Q1 update provided to the market on the 28th of June 2022. Spear's quarterly updates are aimed at keeping the market abreast with how we are trading through the year, and we certainly hope that you will keep track of our progress as we trade through the balance of FY'23. [Operator Instructions] So having a look at what I'm going to be covering in today's presentation. So moving on to the environmental update. Spear's Western Cape-only strategy continues to be proven sound as the Western Cape real estate market recovers ahead of the rest of South Africa. Spear's focused asset management initiatives have continued to bolster portfolio performance providing the stability required to successfully navigate through the half year. The trading environment does remain tough with inflationary pressures continuously building, operating costs creep and interest rate hikes absorbing more disposable income. Defending the net property income line has been tough in this climate, but we have succeeded. The effects of semigration and localization of supply chain solutions have provided great opportunities for Spear within the existing portfolio to add value and to capitalize on this rising trend. The increased interest by international companies seeking to establish a Cape Town office presence bodes well for Spear's commercial office portfolio and the general Cape Town office market. The real estate market in Cape Town remains somewhat detached from what is seen in the rest of South Africa, specifically within the office sector, as high vacancy rates and deep negative reversions plague Gauteng versus active vacancy contraction and flattening rental reversions within the Western Cape. The Western Cape government and the city of Cape Town have accelerated the drive to make Cape Town the first load shedding-free city in South Africa through its energy and electricity policy, recently launching incentive programs for commercial and industrial properties to feed in excess generation into the grid. Currently, the city of Cape Town's new feed-in tariffs are one of the highest in the country at roughly ZAR 1.03 per unit. Construction cranes cover the skyline north to south, east to west with all property types under development. Recently, Statistics South Africa reported that the total value of building plans approved in the Western Cape from January 2022 to June 2022 equated to ZAR 17,86 billion. Now the residential new build portion of that was ZAR 10.3 billion. This growing property rate base will have a long-term effect that benefits both the metro as well as other Western Cape municipalities as infrastructure programs, repairs and maintenance programs can be initiated and maintained, further bolstering the attractiveness of the Western Cape as an investment destination. The Cape Town population numbers are said to swell by a further 1.4 million people by 2030 to approximately 6.2 million people. This is a very positive indicator for Spear's overall business case. Over the last decade, ZAR 102 billion in foreign direct investment inflows have been deployed into the communications sector, renewable energy, business services, ICT and software sector across multiple projects within the Western Cape. The global return to office and work momentum is in full swing, and life starts to -- as life starts to normalize after COVID. Now we don't anticipate Spear to be unaffected by potential office tenancy augmentations as office tenants relook at space requirements going forward. In the 6 months to end of August 2022, no material augmentations have taken place. Demand for Spear's industrial and retail assets have remained very high across the metro given their desirable locations and versatile space offerings. Spear's retention program has yielded robust results with a 95,7% retention rate for the half year. Spear's Western Cape portfolio boasts strong real estate fundamentals: high-quality assets in sought-after locations, strong tenant covenants and an asset management approach that consistently delivers on our mission and strategic objectives. What is our mission? Our mission is to be the leading Western Cape-focused REIT and to continuously operate within the top quartile of our peer group and to grow our distribution per share ahead of inflation on an annualized basis. How have we fared within the half year '23 operating environment? So the FY'23 year commenced as a restorative year for the real estate sector coming out of COVID. The Western Cape real estate has remained in high demand across all property types. However, the momentum has been curbed slightly by the load shedding -- and by recent load shedding, inflationary pressures and interest rate hikes. Currently, the Spear portfolio is generating 100% fixed income. The net income consistency has been maintained on a year-to-date basis amidst these rising pressures and trading pressures with a year-to-date collection of 95% with an interim period collection target of around 98%. Year-to-date portfolio occupancy rate is around 94%. Our relet and renewal program has remained forecast aligned. Spear's portfolio reversions year-to-date have yielded improved metrics compared to the prior year. Half year '23 reversions, negative 3.50% and compared to half year 2022 of negative 5.78%, seeing a 2.28% improvement of our reversion schedules. Our debtors book remains under control and well managed. We are seeing the shrinkage of older debt, which is evident with consistent servicing of current rental obligations by tenants. We have successfully disposed of 2 noncore assets at net premiums to book value, which was the Island Business Park in Paarden Eiland and No. 5 Fitzmaurice Avenue in Epping at a cumulative value of ZAR 107.5 million. This capital will be recycled into a strategy-aligned growth plan for Spear. There's an ongoing and successful implementation of Spear's PV solar program. The focus is within the mid part of this financial year to achieve a 50-plus percent coverage across the Spear portfolio of solar PV plants. Our group LTV ratio is below the 40% strategic percentage that the management team has set out at around 38% to 39% for the interim period. There's been an improvement in our group interest cover ratio, improving from 2.19x to 2.55x as we have added further income restoration to the portfolio. And as announced on SENS, we have initiated the 16,000-square meter redevelopment of Blackheath Park for Bravo Brands, which will be a capital value spend of around ZAR 74 million on a new 10-year lease, which will yield to Spear 9.85%. Moving on to our operational update. So the half year has presented both challenges and opportunities for Spear. So in this slide, I'm presenting with you in the first instance an operational report card. We've segmented, as you have seen previously, by various risk levels from high, medium, low reducing and neutralized. And I'm very pleased that from a current status perspective, we have no high-risk level items to report and no medium-level items to report. We have seen a low risk level on cash availability with ZAR 245 million worth of cash available for growth opportunities for the business. We've seen a reduced risk level across commercial, vacancy creep and rental reversions as we've seen an uptick in letting inquiries and the conversion rate of inquiries to leases on our commercial portfolio. We have seen an encouraging activity on the vacancy -- reduced vacancy creep across the portfolio on a forward-looking basis. And also, we have seen reduced risk as we have improved the overall rent reversion metrics within the portfolio. And then we have neutralized the hospitality portfolio from an income risk perspective through the disposal of the DoubleTree by Hilton prior to the commencement of the FY'23 year. And also, we have the 15 on Orange on a fixed income lease with the Capital Group. Our rent collections also risk levels have been neutralized, being back to pre-COVID collection levels. And the loan-to-value, as I mentioned earlier, below 40%, strategically achieved by the management team to position the business for growth, therefore, neutralizing that as a risk. Moving on to the focus areas where we believe that we need to continue to be proactive and engaged within the portfolio. As a starting point, tenant support measures have been neutralized across the portfolio as we navigate in and through FY'23. So our regional focus allows for intensive asset management across the portfolio, specifically in the areas that keep us awake at night. Now it's no secret that the office sector globally is under pressure, So we're keeping that as a high risk level item. We want to continuously intently focus on the asset management initiatives to derisk that from an income perspective and from a vacancy perspective, which flows into the second risk item, which is, obviously vacancy creep. As I've mentioned, office augmentations discussions are underway. Companies are relooking what that new hybrid model looks like. And those are things that could present a shorter-term potential vacancy creep in any given portfolio across the country, and Spear is no exception. And the other risk level, we have seen an accelerated interest rate hiking cycle. And although we have budgeted accordingly, any major or outside of forecasted interest rate hike would have a potential impact on Spear's operating scenario. Where we've seen a reduced level of risk is in the negative rental reversion segment, as I mentioned, negative 3.50 versus a 5-plus percent in the prior year. So I believe that, that's in line with what we advised the market in FY'22 results presentation that we are starting to see a move towards a more flatter reversion schedule. Our cash availability remained strong, as I've mentioned. Our rent collections have been strong, back to a pre-COVID level. And there's been a neutralization of our loan-to-value, which allows us to go out into the market and look for opportunities for Spear. Having a look at our salient details. Spear owns 30 high-quality Western Cape assets with a portfolio value of ZAR 4.47 billion. Asset values have slightly decreased from FY'22 by 0.17%. Our average property value is ZAR 147 million per property. Our average property value per square meter is ZAR 9,973 a square meter. Our average in-force escalation is 6.37%. Current portfolio GLA is 443,155 square meters of which 56% is made up of industrial, 30% is made up of commercial, 11% made up of retail and 3% made up of hospitality. Portfolio occupancy is at 93.5%, a weighted average lease expiry of 26 months. Management does continuously make a concerted effort to push the WALE as far as possible. We have set an internal target of 36 to 45 months as being the focus. And as we keep adding 10 -- new 10-year leases to the portfolio, we'll start to see that weighted average lease expiry profile continue to push out further and further and further. Our average portfolio rental per square meter is ZAR 101.84 per square meter gross. Our year-to-date collections is 95%. And our forecasted collections at the half year reporting period will be 98%. Having a look at the financial metrics. Spear is on track to achieve a DIPS guidance of 5% to 7% growth on the FY'22 results. Spear will maintain a 90% payout ratio, in line with our cash retention strategy and our optimized taxation outcomes. Spear's SA REIT cost-to-income ratio year-to-date was 43. 7%. Spear's SA REIT admin cost-to-income ratio at year-end was -- year-to-date was 6.54%, which is slightly down from 6.56% at FY'22. And maintaining a low overhead cost structure is really a key focus for the business, and we are looking at a normalized range of around 6.4% to 6.5% going forward. Our tangible net asset value on a year-to-date basis is ZAR 11.22 per share, which is a decrease from the FY'22, which was ZAR 11.30. Our loan-to-value is at 38.96% and that is, in my opinion, a very acceptable loan-to-value to really position the business for further asset growth over the course of the year in terms of the allocated assets that we choose to acquire. Our fixed debt ratio is currently at 66.78%. This is within our debt hedge percentage strategy to have between 63% and 75% of any of our debt hedged at any given time for a period of up to 36 months. Our average debt expiry profile, 22 months with no refinancing risk. Our average cost of debt is 7.79%. Average cost of fixed debt is 8.34%. And our average cost of variable debt at 6.99%. So moving on to our collections. Spear for the half year we've billed ZAR 290 million of revenue. We've collected ZAR 274.2 million. It's a year-to-date collection as at 22nd August of 94.56%. These collections include billings for August. The year-to-date collections are largely in line with our forecast as they trend back to what a pre-COVID recovery -- or pre-COVID collection profile looked like. As mentioned, it's encouraging to see all the debt being serviced with current rental obligations. Billings do reflect all credits and deferments, inclusive of recoveries. But as I mentioned earlier, that any deferments of credits are now practically and pretty much out of the system. And our rental collection profile definitely depicts a pre-COVID operating environment. And the tenant receivables for the half year, which amounted to ZAR 15.8 million, excluding VAT are not just debtors. These are also agreements that we have with some of our larger tenants that settle both rental and utility charges at month end. What have we collected on a segmented basis? Within the industrial part of the portfolio, we've collected 95% of our rent. Within the commercial portfolio, we've collected 96% of our rent. Within hospitality, we've collected 96%. And within retail, we've collected 95%. Moving on to our letting activity. So this table reflects what the letting activity has been for the interim period. I'm extremely encouraged to see that we had 57,000 square meters come up for renewal and relet, of which just under 55,000 was renewed and relet, giving us a 95.7% tenant retention rate. The amount of GLA renewed during the half year is effectively around 12.38% of total portfolio GLA. And furthermore, we have seen that trend of moving from deep -- or mid negative to flat and barely negative reversions. As you can see on the commercial portfolio, a negative reversion of 1.54%; on the industrial portfolio, a positive reversion of 1.78%; on the retail portfolio, a positive reversion of 4.24%, giving us a total negative reversion of 3.50% across the portfolio. Moving on to our balance sheet and funding update. Spear's LTV covenant of 50% is what is our strictest covenant with our banks, currently operating at between 38% and 39%. Spear has an ICR covenant of 2x with a current ICR of 2.55, which, again, just as a reminder, is a notable improvement from 2.19x in FY'22 as we've continuously restored income, and might I add, we've also absorbed recent interest rate hikes into those numbers. So I'm very encouraged by this ongoing strengthening of Spear's interest cover ratio. And portfolio valuations have also remained conservative and we do believe that fair value increases will be forthcoming over the course of the year. Just having a look at the spread of debt expiry from fixed and variable. We have on weighted average variable expiry, 30 months, as I mentioned. We are in advanced discussions with both our funders on the refinancing of portfolio debt that's coming up over the next couple of months. And we have no reason to believe that this will not be implemented in line with our forecast. Also you will see that there has been a creep from FY'22 to current on the average interest rate. We are around -- up around 47 basis points on our average interest rate and up around 107 basis points on our weighted average variable interest rate. Now we do maintain excellent relationship with our funders and which are -- which have more -- on more than one occasion confirmed clear alignment with Spear strategy. Furthermore, we have not valued any of our bulk within our portfolio into the current valuations. So, a, it's a clear NAV unlock for shareholders. But when that value gets unlocked, you'll see an organic increase in portfolio value and a further shrinkage of the overall loan-to-value of Spear REIT. Just moving into our sectoral performance. So Spear's overall portfolio continues to deliver operationally as has been displayed during the earlier parts of this presentation. So now itemizing specific sectoral performance for the year -- on a year-to-date basis provides you, as a shareholder, deeper context to the trading environment and where management must continue to prioritize asset management initiatives. Having a look at our retail portfolio comprised of about 11% of total portfolio GLA. Defensively, 41% of our retail GLA is made up of national tenants. Trading has been consistent with consistent positive tenant feedback irrespective of the inflationary pressures felt in the market. We have been encouraged by the strength of the credit that shoppers have available to them irrespective of the interest rate environment. Our convenience and retail assets are all -- have no reliance on the local or international tourism market. Occupancy rate of just 93%. Our collections have been maintained at 95%. Our renewals have all been in line with our forecast. And what's even more encouraging is that larger retailers are looking to increase their market share with the introduction of new brands, new space requirements focused on the convenience retail market. And we believe that we will be one of the net beneficiaries as we continue to scale our retail portfolio. Having a look at the commercial portfolio, making up 30% of total portfolio GLA. As mentioned in the environmental update, we've seen numerous national and international firms establishing a greater presence in Cape Town resulting in the letting activity yielding positive results. I'm pleased to announce that Spear has recently entered into a 10-year lease at No. 2 Long Street with one of the largest global courier companies, DHL, for its Sub-Saharan Africa hub, which will be -- house their office requirements for Sub-Saharan Africa in addition to a state-of-the-art ground floor customer engagement and delivery hub of around 500 square meters within No. 2 Long Street. This will not just bolster the WALE of this particular property, but also of the portfolio in addition to also improving the quality of the tenant covenant within No. 2 Long Street. Numerous United Kingdom-based BPO firms are in the process of establishing large operational presence in Cape Town. And we do believe that the development of the Amazon campus, which is in and of itself, a great step in the right direction for the Western Cape, will also have cascading benefits for other businesses providing services to a big international IT group and delivery group like Amazon. And we believe that there's numerous other opportunities that will flow from that. Occupancy rate is at 85.12%. Collections are at 96%. We have seen a return-to-office momentum continuing, but there's no new model yet. The hybrid regime still remains fluent and lots of conversations are ongoing with tenants and with commentators in the market, but I don't believe that there's yet a clear permanent plan as every business has different wants and different needs. Office augmentation on renewals may create some short-term vacancy creep within the commercial portfolio. However, the notable improvement in the trading environment will, I believe, absorb this demand -- or will absorb this vacancy creep in the near term. Having a look at the industrial portfolio, making up the lion's share of the portfolio on a GLA perspective of 56% of the total portfolio. We've seen the robust performance within our well-located and versatile industrial portfolio, which really has been driving the high occupancy rate. We see that demand is outpacing supply. And again, even in an inflationary environment, having existing assets and not having to develop new assets, we can -- we see this as a competitive advantage. Current occupancy level is at 97.8%. Collections at 95%. And across the board, in our multi-let industrial parks, we see strong demand for space with the balance of our single-tenanted assets being let on long-term leases. Believe that the deglobalization and localization of supply chain will be a major tailwind for Spear as portfolio assets are well positioned from a locality and cost-per-square meter perspective to always remain in contention to secure new tenants. As I mentioned earlier, we announced on SENS the redevelopment of Blackheath Park for Bravo Brands, and we will see the growth of that tenancy reach up to 42,000 square meters over the next 5 to 7 years. Having a look at our hospitality asset, currently 3% of the total portfolio. 15 on Orange continues to deliver 100% fixed net income to Spear. Spear has no exposure to the hotel operations. The hotel operator continues to invest their own capital into further property enhancements. We have, however, seen that the failure of British Airways and Kulula have negatively impacted the hospitality market recovery with regard to local and business travel as domestic flight costs have creeped up exceptionally. There's been, however, a noticeable increase in international travelers led by the U.S. markets and the production services industry requiring accommodation in Cape Town and surrounds. The strong return in demand for meetings and conferences have created further demand in the accommodation requirements within the hospitality sector. Having a look at the general business and portfolio update. As mentioned, trading conditions are showing continued improvement across the portfolio. The industrial and retail portfolio remained resilient. The office portfolio momentum continues with recent notable new lets. The last remaining hospitality asset is 100% fixed income and yielding. The ongoing implementation of our solar PV strategy and water augmentation initiatives will continue to bolster our ESG strategy. Rental collections have been robust and consistent, as I mentioned, moving back to a pre-COVID level. Our debtors book remains under control and actively managed. However, the persistent load shedding has created operational cost creep, which we have to deal with in the portfolio. Our LTV remains in line with our strategy, positioning Spear for growth. And we have, over the last 9 months, successfully disposed of ZAR 179 million worth of noncore assets, which we will recycle into strategy-aligned assets within the Western Cape as and when those opportunities present themselves. Moving on to our outlook. The Western Cape real estate sector has shown consistent resilience across property types on a year-to-date basis and we believe this will continue to improve. Good governance across provincial and metropolitan spheres enhances the investment appetite for Western Cape real estate and commerce. Cape Town will be the first load shedding-free metro in South Africa, and Spear will continue to do its part through the execution of our ESG strategy. Spear will maintain its investment bias towards industrial warehousing, logistics and retail assets within the Western Cape. Spear will see the realization in the near term of organic and inorganic growth opportunities for the portfolio. There will be a consistent NAV unlock for shareholders through the development and redevelopment of embedded portfolio bulk rights, which, again, I reiterate, have not been valued into the current portfolio valuations. Spear's investment universe will continue to expand as numerous new growth nodes are established within the Western Cape with semigration one of the drivers of this development activity. Spears portfolio remains defensive underpinned by strong lease covenants and located in highly desirable locations within the Western Cape. And our hands-on asset management approach will continue to propel the business forward into achieving its market guidance for FY'23. Let me look at our guidance. Spear will maintain a Western Cape focus in line with our strategy. We will recycle capital into strategy-aligned assets. We'll seek out income enhancement opportunities through the investment into high-quality real estate assets. Our proximity to the portfolio assets will remain a key pillar of Spear's operating strategy, resulting in enhanced market opportunities. Spear's FY'23 guidance, as advised to the market in May 2022, remains on track being a DIPS growth of 5% to 7% on FY '22's DIPS. The guidance must however be read in conjunction with the following assumptions: no further COVID-related lockdowns; vacancies are reduced in line with management's forecast; recent lease renewals are concluded per management's forecast; no major tenant failures occur during the year; no major increases in the SARB repo rate other than what we've already budgeted for, for the balance of the year; tenants being able to successfully absorb rising costs associated with utility charges, municipal rates and consumption charges for diesel-powered generators; and then load shedding stages do not consistently go beyond Stage 4 during the balance of FY'23. Any material change in the above assumptions may affect our forecast. However, we will maintain our quarterly update initiatives to the market and will remain accessible to the market right throughout the year. This brings us to the end of the preclose presentation. I want to extend my thanks for your time this morning, and we'll be back in a few minutes' time. We'll be joined by our CFO, Christiaan Barnard, to take any questions that may have come up during the presentation. Thank you very much. [Break]

Welcome back, and I'm joined here by our CFO, Christiaan Barnard, and we're going to just see if we have any questions. I think there were about 3 questions that came through during the presentation. And I have Kim, our CIO, that's going to be asking the questions to us.

The first question, thank you Quintin, is from Marcus from Catalyst. Could you guys give more color on the positive 4% reversions for retail? Firstly, how were the escalations on the leases that rolled off that achieved these positive revisions?

So our general escalation rates within the retail ranged from between 6.5% to 7.5%. And the positive reversions were, firstly, as a result of the general asking rental across the portfolio and the passing rentals across the portfolio are not over market. Hence, we were able to get a between 6.5% and 7.5% growth on the closing rental being the last rate was committed to payable on the lease that expired given the fact that the rentals were slightly below market or on market. And also given the fact that the convenience retail subsector within the real estate market is a very hot commodity at the moment, and retailers do not want to lose space in the market and we believe that, that is an advantage to owning these convenience retail assets.

Thank you. The second part of the question is, were any leases that contributed to these reversions struck at artificially low rates during the heat of the pandemic? What I'm trying to ascertain is if we can deduce that market rents are growing ahead of escalations or if there are any once-off anomalies.

So within the retail portfolio, we didn't have many once-off anomalies given the fact that the convenience retail portfolio traded extremely well throughout COVID. On the office portfolio, yes, we had a 500-square meter renewal that was struck during the COVID pandemic where the tenant was on a COVID-related rate and that lease has now been renewed for 5 years at a market-related rate. So for argument's sake, if they were paying ZAR 105 a square meter at expiry as a result of a COVID-related rate, they're now paying ZAR 150 a square meter as their new rental rate going forward and that will escalate at 7% over the next 5 years.

Thank you. There's a question from [ Anton Dahuda ] from Coronation Fund Managers. Christiaan, good day. Is the DHL lease at 2 Long Street already in the occupancy of 85.12% of the commercial sector?