Spear Reit Limited (SEA) Earnings Call Transcript & Summary

Good morning, and thank you for joining Spear's Half year 2024 Pre-close Presentation. We appreciate you taking the time to be with us today, and I trust that the presentation today would be informative. The first half of the year has been challenging as the macroeconomic environment provides no respite to the tough trading conditions. Our world view remains that real estate is a long-term business, and we simply must continue to do the basics right on a day-to-day basis, and the results will continue to flow. Despite the challenging trading environment, we continue to see green shoots within our operating context. The first half of the year has certainly tested resilience and asset management skills on a day-to-day basis. To date, Spear remains the only regionally focused REIT listed on the JSE. Proximity to our assets and our tenants is excellent and remains a key part of our operating strategy. Spear obtains its specialization through 100% Western Cape investment strategy and our diversification with the investment into high-quality industrial, commercial, retail and mixed-use assets. The first 6 months of the year have operationally traded in line with management's expectations. However, as it has been experienced in South Africa and across the globe, business operations have experienced cost creep pressures that have manifested placing pressure on income growth expectations. The pre-close today will by and large echo the Q1 update provided to the market on the 5th of July 2023. If you have any questions during the course of the presentation, please e-mail them through to [email protected], and will be answered after the presentation. Just having a look at what I'm going to be covering in the presentation today, just moving on to our environmental update. Spear's mission is to be the leading Western Cape focused REIT and to consistently grow our distribution per share ahead of inflation on an annualized basis and also to operate within the top quartile of our peer group. How has the half year been from an operating context perspective? The half year trading conditions remain challenging due to persistent load shedding, rising operating cost creep and subdued economic growth. The Western Cape remains a positive outlier in the overall SA context, but has not been immune to the shackles of load shedding and its associated costs. Operating cost creep has remained a concern, in particular, within these 4 areas. Increased interest rates have in the short term impacted profitability, but won't be structural in nature as inflation cools and rates start to taper. Material increases in City of Cape Town rates and taxes are absorbed with most increases recovered from tenants but with a lag effect. Nonrecurring repairs and maintenance due to severe weather conditions in the Cape have increased expenditure to higher than normal levels, but we have done what is needed to keep the core portfolio stable and generating cash flows. And finally, the absorption of unrecoverable diesel costs relating to certain common areas and vacant areas within the portfolio. Within the disposal context, as announced on SENS, the sale of the Liberty Life Building is on track to conclude by the end of the financial year. Per the FY '23 results presentation, this disposal will reduce Spear's LTV by approximately 450 basis points to the mid-50% level. Year-to-date, portfolio occupancy rates remain above 93% with improved letting activity milestones achieved during the half year, increasing occupancies to 93.37% and increasing occupied GLA at the half year to 398,309 square meters. Having a look at our rent reversions. The half year portfolio rent reversions have shown half year to half year improvements being a positive rental reversion percentage of 2.51% on a portfolio level compared to half year 2023 negative north point -- 4.08%. In excess of 72,000 square meters of renewals and new lets have been concluded during the half year, which is close to 85% of our total FY '24 renewals for the year. Our in-force escalations remained robust at 7.4%, noting a marked increase from HY '23, where it was at 6.34%. Spear's debtors book remains actively managed. Tenant payments have remained positive with minor outliers, showing some strain in the SME part of the portfolio. Given the current discount to our net asset value as advised on SENS and within our AGM authorities, Spear's share repurchase initiatives for the half year amounted to the repurchasing of 3.07 million shares. At the half year, approximately 8.82% of shares in issue have been repurchased as part of our three-pronged capital allocation strategy. The fully let Island Urban Logistics Park has transferred into the portfolio on the 9th of May 2023, adding further impetus to the portfolio rebalancing strategy, increasing total industrial GLA to 58% of total -- of the total Spear portfolio. In terms of our PV Solar, Spear has every opportunity to seek to implement its PV Solar strategy. 54% of portfolio assets now have installed PV Solar. A further 2 megawatts of new project is underway, which will increase coverage to -- in excess of 60% of portfolio covered in PV Solar with an installed capacity of up to 8 megawatts before the end of the year. However, Stage 6 load shedding has had an impeding effect on performance of the systems, given the fact that these systems are all [ retired ]. In terms of the development growth of our business, we are pleased to announce that Phase 1 of the Airport Business Park, bulk infrastructure in George will commence on the 1st of September 2023. The 30,000 square meter industrial development will be tenant driven, not speculative, with units ranging from approximately 400 square meters to 10,000 square meters in size. Just having a look at our operational update. Operational focus areas for the half year have been summarized in 7 key points: commercial vacancies, vacancy creep mitigation measures, cost creep impact and mitigation, mitigation measures against negative rental reversions, cash availability and treasury management, robust collections, loan-to-value strategic band management. How have we done for the half year. In terms of commercial vacancies, we've seen an improved lease conversions with #1 Waterhouse, 11,000 square meter GLA and Bloemhof 4,000 square meter GLA being fully let during the half year, which will start to provide additional income underpin from the third quarter. Vacancy rate, we've seen positive market activity portfolio-wide, which has resulted in improved portfolio occupancy rates. As mentioned in the environmental update, cost creep has been a reality with increased interest rates having an impact on profitability, the increase in City of Cape Town rates and taxes, creating a lag effect on recovery and the nonrecurring repairs and maintenance due to the 100-year rains in Cape Town. In terms of the rent reversions, we've seen an improved rent reversion from FY '23 to HY '24, and we anticipate that trend to continue. Cash availability and treasury management has been strong in excess of ZAR 130 million in liquidity availability. Rent collections for the half year have been at 96%, and that is continuously improving. And our loan-to-value is within our strategic band of between 38% and 43% for the half year. Salient details. Spear owns 28 high-quality Western Cape assets, with a portfolio value of ZAR 4.26 billion. Portfolio value has increased from the end of the last financial year to the half year by 4.98%, which is the transferring in of the Island Urban Logistics Park into the portfolio. Spear's average property value is ZAR 156 million per property. Our average property value per square meter is ZAR 10,255 per square meter. Our average in-force escalation, 7.4% with a portfolio GLA of 426,588 square meters. Portfolio occupancy rate, which has been -- also been a hallmark of our business since inception is high in the mid-90 percentile. Our weighted average lease expiry profile is 27 months. Management continues to make a concerted effort to push out as this wale as far as possible. But as always, our focus remains on rent and tenant preservation in the short, medium and long term. Thus, flexibility must be given in certain circumstances. An internal target remains of between 36 and 45 months. Average portfolio rental rate per square meter is ZAR 104.21 per square meter gross, with a half year collection profile of 96.01%. Having a look at our financial snapshot. Management had proposed a half year '24 payout ratio of between 93% and 95%. Spear's SA REIT cost-to-income ratio for the half year is 43.37% versus FY '23 of 43.45%, a marginal decline. Spear's SA REIT administration cost-to-income ratio at half year is 5.99% versus FY '23 at 6.50%, which is 51 basis points lower. Our team has done a great job in keeping strict cost controls in place where and when possible. Spear's tangible net asset value, ZAR 11.42 per share, being a decrease of 0.52% from FY '23, which is a direct result of the conditional share plan issuance to qualifying staff members. Spear's loan-to-value will be around the 39% to 40.50% mark and declining towards the 35% to 36% level when the Liberty Life Building transfers before the end of the financial year. Spear's fixed debt ratio is at 45%. Our strategy is to be between 65% and 75% hedged at any given time. However, currently, we all believe our strategic band, given the high cost of derivatives, and we are disposing of assets at negative value to settle debt, which is -- in an accretive manner, which organically ups our fixed debt ratio. Our average debt expiry profile is 24 months. Our average cost of debt, 9.35%, our average cost of fixed debt, 8.28%, and our average cost of variable debt, 10.21%. I will provide some more granular detail on the stack-up from FY '23 to the half year in terms of our debt portfolio shortly. Moving on to our collections. The half year collections were in line with management's expectations. Encouragingly, we continue to see all the debt being serviced and settled with current rental obligations. For the half year, we billed ZAR 288.2 million in rental. We collected ZAR 276.7 million, so collection percentage of 96.01%. How has that stack up per sector. On the commercial portfolio, we collected 98% of our rent, on the industrial portfolio, 92% of our rent. This number is artificially on the lower side, given the fact that our large power user tenants pay their rent at the beginning of the month and the utility charges at the end of the month. And this is -- this total collection reflects as at 21 August 2023. So we will see this 92% number increase at the end of August and 95% of our retail rentals were collected. Collections include the month of August, but exclude utilities, as I mentioned, for the large power users. The billings reflect revenue inclusive of recoveries. Tenant receivables amounted to ZAR 11.5 million for the half year. We have had some tougher legal cases, but we are confident that we will recover a meaningful sense in the [indiscernible] in those instances, given other recent successes that we've had in the court. Moving on to our letting activity. For the half year, 69,925 square meters came up for expiry and relet. We successfully concluded renewals and relets of 72,246 square meters with a positive portfolio reversion rate of 2.51%. It's noteworthy that just under 80% of all letting activity for the half year was done within the industrial portfolio, further building on the positive Q1 update we gave within that sectoral performance of the industrial portfolio. The third quarter should bolster both office and retail letting activity. As mentioned earlier in the presentation, with #1 Waterhouse being fully let with the Bloemhof building being fully let, in addition to an offer to lease received on the entire vacant portion of space in the Liberty Life Building, which is just under 3,000 square meters. Once concluded, our entire Century City asset base of commercial offices will be fully let, which comprises 35% of the total office portfolio. The negative reversion in retail, we provided context to that to the market in our Q1 update. And those -- the direct result of that negative reversion were long-term retail leases that we really factored into our income statement assumptions for the year that were renewed at a rental -- at a market-related rental, given the fact that those rentals had escalated way above market coming off a 10-year lease. Moving on to our balance sheet and funding update. Spear continues to operate with a robust balance sheet, a very actively managed balance sheet. We're operating well within our covenants. Our strictest covenants are 50% loan to value and an interest cover ratio of 2x. At the half -- year-to-date July, loan-to-value in the range of 40.49% and an interest cover ratio of 2.39x. Just to note that the 40.49% does not take into account any fair value adjustments done at the half year, where we do anticipate to see some value uptick within the portfolio. Therefore, this is a -- I prefaced it earlier to say that it's probably going to be between 39% and 40.49% for the half year. Having a look at the finance cost stack up and expiry profile, you will see the effect of the interest rate movements between the financial year 2023 and the half year. Our weighted average variable expiry is 24 months, our weighted average fixed expiry 12 months, our weighted average interest rate, 9.35%, our weighted average variable rate, 10.21% and our weighted average fixed rate 8.28%. Given the fact that interest rate swaps and hedges are very expensive at the moment, we have chosen to [ buy ] that time and we daily monitor the movement in the market, and we've seen a very favorable turn in the bond rates and the FRA curve, and we anticipate to strike at an appropriate time that's right for the business, given the fact that we are seeing a declining inflation environment and the forecasted cut in the interest rates. Moving on to our sectoral performance. Spear's portfolio has continued to display resilience across the board. The segmented sectoral performance provides more operational detail on the environmental conditions and how each sector asset type is performing. Having a look at our retail portfolio, trading has been consistent with convenience and destination -- within the convenience and destination retail portfolio. Convenience retail and destination retail makes up 41% nationals, which is in and of itself, very defensive and further offers credit risk mitigation. Within our retail portfolio, we placed no reliance on local or international tourism markets. We have a robust occupancy rate of 94.49% with a collection rate of 95%. As mentioned, the negative print on half year rent reversions were factored into the FY '24 income statement assumptions. And we continue to be encouraged to see how larger retailers are looking to increase their market share with new brands, new space requirements focused on the convenience retail market, which we believe, as we continue to scale our retail portfolio, we will be a net beneficiary of this movement in the market. Having a look at the commercial portfolio. In terms of offices, very positive progress has been made in vacancy contraction within the office subsector as letting momentum increases, occupancy rate of 85.67%, which is a 109 basis point increase from Q1, with collections robust at 98%. The return to office momentum remains extremely strong, with vacancy rates across Cape Town dropping. The international BPO firms have continued to establish larger operating presences in Cape Town, which has been one of the biggest drivers behind the drop in the vacancy rate across all established nodes in Cape Town. As mentioned earlier, 1 Waterhouse and Bloemhof fully let from the third quarter FY '24, and as mentioned in the FY '23 results presentation, I did say that the occupancy rate at the Upper Eastside offices was something that was really bothering us. And we did put that -- we enacted a very aggressive letting strategy and I am pleased to report that occupancy has improved from 60% occupancy rate to 80% occupancy rate at the half year. As mentioned, we received an offer to lease on 2,897 square meters of vacancy at the Liberty Life Building. Once that's concluded, this will bode very well for the overall portfolio vacancy reduction strategy regardless of whether or not the property is exiting the portfolio in the near term. Having a look at Industrial, continues to provide strong trading during the year with ongoing positive rental reversion print. The robust performance in our view, is a result of a well-located and versatile asset class, which are key drivers behind the high occupancy rate within the industrial portfolio. Occupancy rate of 97.28% with collections at 92%. And again, just a reminder, the caveat behind that is that large power user utilities are recovered at month end, rental paid at the beginning of the month. Strong demand remains across the board for Spear's multi-let industrial parks with the balance of single-tenanted larger assets under long-term leases. Sectorally, the in-force escalation is robust at 7.63% and the availability of more consistent electricity supply within the City of Cape Town has given us a competitive advantage given the fact that the bulk of Spear's assets are located within the City of Cape Town supply. The Island Urban Logistics Park is transferred into the portfolio, 21,000 square meters of fully let industrial -- high-quality industrial GLA. And as mentioned earlier, very exciting the commencement of the bulk infrastructure for the George Airport Business Park development. So when we look at general business update across the sectors. The operating environment remains extremely challenging. Despite the trading environment, the core portfolio is trading well with key operational milestones consistently being achieved. The office portfolio encouragingly continues to see momentum with numerous new leases concluded on a year-to-date basis, as can be seen by the reduction in the overall vacancy rate in this presentation. The ongoing implementation of Solar PV and Water Augmentation initiatives will continue to drive the Spear's people, planet, and profit approach given the fact that we are pushing ahead with numerous new solar projects. We have in excess of 18,000 solar panels installed across our portfolio, and that will continue on every acquisition we make and every development we do, we'll find a sustainability solution embedded in that acquisition or development. Rent collections remain in line with our forecasts. Receivables remain at acceptable levels despite some stress within the SME tenancies. Persistent load shedding has created cost creep in addition to interest rates -- increased interest rates. 26 out of Spear's 28 assets are supplied electricity by the City of Cape Town and further portfolio enhancement opportunities are being assessed and unlocked in line with management strategy given the undeveloped bulk on the existing assets. So moving on to our outlook. Amid extremely tough trading conditions, Spear's Western Cape-only portfolio remains well placed to benefit from a shift in real estate fundamentals geographically along with the tailwinds created by the effect of semigration and good governance. Material cost creep remains a growth inhibitor as finance costs, diesel costs, insurance, Sasria, rates and taxes costs are absorbing top-line growth. Municipal and provincial infrastructure continues to propel the Western Cape into the leading investment and economic hub in South Africa. Currently, the Western Cape contributed ZAR 770 billion to the South African GDP. It is the Premier's intention and all of us collectively as a business to create a ZAR 1 trillion economy within the Western Cape, and we are all focused on achieving that goal. Load shedding remains a major threat to any meaningful economic recovery for South African businesses. And we truly trust that a solution -- a longer-term solution can be found within South Africa. Spear's ESG strategy remains focused on delivering our people, planet and profit-aligned outcome. Management remains optimistic that the top of the interest rate cycle has been reached in South Africa, presenting potential near-term finance cost tailwinds. Spear will remain focused on its growth strategy into high-quality Western Cape assets that offer long-term sustainable cash flows and growing yields. Our investment bias will remain towards industrial warehousing, logistics and convenience retail assets to grow the portfolio with potential data center opportunities being explored. Management's three-pronged capital allocation strategy has remained sound as current trading conditions limit asset growth opportunities in line with the yield requirements that we, as a business require and have presented share repurchase opportunities at a material discount to the net asset value of the business. Spear's ethos of operating with a high occupancy rate remains a top priority as portfolio vacancy reductions initiatives bear fruit. And Spear's portfolio continues to be located in highly desirable nodes, is defensive, underpinned by strong lease covenants and high-quality tenants. Moving along to our guidance. The macroeconomic climate remains challenging as the longer-term impact of load shedding and other cost creeps have not yet been fully felt by South African business. The negative impact of cost creep across the board will place further pressure on business margins, cost of occupancies and net property income. Given the available information management has at its disposal at the half year and the impact across the board that cost creep has had on business operations, which we were unable to mitigate it. Distributable income per share growth for the half year is expected to be flat to marginally negative at around 1.5% compared to the half year 2023. However, distribution per share growth will be marginally up for the half year based upon the higher payout ratio proposed of between 93% and 95% versus the half year '23 payout ratio of 90%. Spear's guidance for the remainder of FY '23 remains informed by and influenced by the following: load shedding stages are mostly limited between stage 1 and stage 4 in the City of Cape Town. Vacancies are reduced in line with management's forecast. Lease renewals are concluded per management's forecast. No major tenant failures occurred during the year. Tenants are able to successfully absorb rising costs associated with utility charges, municipal charges and diesel charges and no further increases in the South African Reserve Bank repo rate for the balance of FY '24. And finally, no civil unrest within Cape Town, the Western Cape or South Africa. Any changes in the above assumption may affect our forecast. And a reminder, this has not been reviewed by group auditors. This now brings us to the end of our pre-close presentation. I wish to thank you all for attending today, and we'll be back shortly to take any questions, where I'll be joined by our CFO, Christiaan Barnard. Thank you very much.

Welcome back again. We haven't received many questions. We received one question from Camissa Asset Management. And I'll just ask Christiaan Barnard, our CFO, just to read out the question, Christiaan.

Thanks, Quintin. Marina asked, to what extent does your guidance on a per share basis, DPS, DIPS, NAV per share, taking into account the reduce share count due to the 8.8% of share and issue being repurchased.

Yes, it does take that into account in our numbers.

There's no further questions.

Well, we've left the stream open for a little while longer. And I think there might have been a little bit of Internet challenges. So if there are any further questions, please feel free to contact us on our respective e-mail addresses or e-mail us on [email protected]. Thank you very much. Thank you for your support and God bless.