Spear Reit Limited (SEA) Earnings Call Transcript & Summary

Good morning, and thank you for joining Spear's HY 2025 pre-close presentation. It's just on 11:00, and we're going to kick off. And we are greeting you from a Chile Cape Town. The first half of the year has not been without its challenges, but also has been a period of renewed optimism and hope for all South Africans. We've experienced a free, fair and peaceful national election, which was held on the 29 May, 2024. And what emerged from the ballot boxes was truly the will of the people with the formation of the government of National Unity. As a business and as a South African, we fully support the GNU and trust that they will make meaningful strides into growing this beautiful country, and its economy for the benefit of our people. The Western Cape experienced governance continuity under the astute leadership of Premier ANNAN Wendy and his phenomenal team, and we look forward to continued collaboration and benefit of the working relationship we have with the provincial government, the local authority, so we can all continue to drive the growth objectives of the Western Cape. As mentioned in the FY '24 final results presentation, we were not satisfied with the extent of the Spear vacancy factor at the end of the last financial period. And we undertook to shareholders that we would intently focus on mitigating this vacancy further and further in the portfolio. I'm extremely proud today as to how the team has delivered on this mission and how they have taken hold of that and delivered on the promise that we made to shareholders in May of this year. I believe that this will reflect in the pre-close today and will also be a growth driver for us in the 2025 financial year. Despite the challenging trading environment, higher interest rate environment, we are still very optimistic that tough trading conditions and tough economic conditions will not remain with us forever. And we are now starting to see the economy pick up, tenant demand increase and a lot of activity within the real estate sector as we navigate through the balance of the year. As the only regionally focused REIT listed on the JSE Spear has benefited and will continue to benefit from its Western Cape only focus and the strengthening of the macroeconomic conditions, both in the Western Cape and in South Africa. On a year-to-date basis, for the most part, operationally, the business has traded in line with management's forecast with the exception of the severe weather conditions experienced during the months of June to August of this year. However, as always, we have acted quickly and decisively to ensure operational continuity throughout the period. If you have any questions during the course of the presentation this morning, please e-mail them through to [email protected] and we'll answer them straight after the presentation. Just having a look at what I'm going to cover in the presentation today, and we'll kick off with the environmental and operational update. Spear's mission is to be the leading Western Cape focused REIT and to grow our distribution per share and to also operate within the top quartile of our peer group. Spear's year-to-date can be summarized as follows. In terms of operating environment, trading conditions have remained challenging due to the impact of rising operating costs, subdued economic growth and higher interest rates. However, green shoots have accelerated post the formation of the GNU as tenant commitments both in the new let space and lease renewals show notable momentum, success and trust in a bit of tomorrow. We've seen a material let up in Spear's vacancies, which are reflective of an improved trading environment, in particular, from the month of June 2024. We are now here today with around 155 days without load shedding. This has boosted tenant output, confidence and has bolstered the greater economic activity across the board. However, as mentioned, the severe weather conditions, obviously, have had an impact. However, we believe that we'll be in a position to work hard and absorb these impacts as we navigate through the balance of FY '25. In terms of operating costs, they have remained a challenge. The interest rate environment for most businesses in South Africa has had a negative impact on the bottom line. However, we are optimistic that by come September, the South African Reserve Bank will start to reduce the interest rates of the country, as we've seen both global and local factors pointing in this direction. We've incurred higher repairs and maintenance costs due to the severe weather conditions. But as mentioned earlier, we've done what we've needed to do to ensure portfolio continuity. We've absorbed the City of Cape Town's winter electricity tariff in the first 6 months of the year. As always, the balance of the 6 months of the year ahead will see us equaling out on the impact of this winter tariff in the first 6 months of the year. And then insurance and SASRIA costs have increased in excess of the norm, which will have to be absorbed in the FY 2025 year. As reinsurers have augmented treaties between local insurance companies and unfortunately, the pond upon which we have -- within which we have to fish has continued to become smaller and smaller as the [ SM ] market becomes a smaller player in the global scale. Having a look at our portfolio indicators, which is an exciting part of the presentation. Year-to-date, portfolio occupancy rates have increased by 200 basis points from FY '24 year-end of 93% occupancy rate to a HY 2025 year-to-date, 95% which, again, is just the thematic of the improved letting activity across the board within the portfolio. Occupied GLA at the half year was 385,424 square meters. Our portfolio in-force escalations have been maintained at a robust 7.47% and our weighted average lease expiry at 26 months. In terms of rental reversions for the half year, portfolio rent reversions have continued to show improvements from FY 2024, where we printed a negative 0.37% rent reversion on the portfolio level, that has improved to a positive 4.5% on a portfolio level. We have furthermore renewed and relet just under 50,000 square meters of gross lettable area year-to-date, which is close to about 12.23% of total portfolio. What is also important to note that on average, Spear has about 16% to 17% of its portfolio that comes up for renewal and relet on an annualized basis. And what the 49,642 square meters tells us is that we're already 70% of the way through our FY '25 renewal and relet profile, which is extremely positive. Moving on to our collections. Spear's debtors book continues to be actively managed, collections have come in at just over 95%. Bearing in mind that Spear's large power user industrial tenants pay their electricity accounts at the end of the month, which means that this is, at a point in time, that's just over 95% collections, and that has already exceeded the 96% at the time of giving this presentation. The debtors book is under control, and it's been consistent. However, there have been some pressures in terms of tenant payment profiles, which is being managed, and we are assuring our management and our Board that this will not impact the business' profitability for the year. Having a look at our acquisitive growth. As you are aware, we have acquired the Emira Western Cape portfolio of assets that were 100% owned by Emira, in a transaction of ZAR 1.146 billion. This transaction is now unconditional. All CPs have been fulfilled, and we are now in the implementation phase of the transaction, and we anticipate the transfer of the portfolio by December 2024. Just a reminder, the portfolio is a mixed portfolio of industrial, commercial, medical, retail assets of just under 94,000 square meters with a post transfer initial yield of 10.1%. In terms of capital recycling activity, in the first quarter of FY '25, Spear transferred out the Liberty Life Building, which was disposed off for ZAR 400 million. We sold the 142 Edward Street building in Tiger Valley, also in the first quarter of this year for ZAR 43 million. And the net proceeds of ZAR 160 million from those transfers and sales will be utilized to fund the acquisition of the Emira Western Cape portfolio. Furthermore, as announced on SENS, we have in the process of disposing of 100 fairways close in 1 city to the city of Cape Time, which is anticipated to transfer prior to the end of the financial year. Notably, no debt was drawn against this property and the full disposal proceeds will be recycled in line with Spear's capital allocation program. Moving along to our LTV and hedging. As at July 2024, Spears loan-to-value was at 25.69%, displaying an extremely robust balance sheet. Spear's hedging ratio post the disposals earlier mentioned, has increased to 84.62%, now management's internal band is to operate at between 65% and 75% hedge ratio at any given time. The 84.62% is above the range that we would normally operate in. However, that should normalize back into the range that we target post the transfer of the Emira assets into the Spear portfolio. Our interest cover ratio as of July is just under 3x, which has improved from FY '24, which was disclosed at 2.28x. In terms of sustainability, we have been actively looking to enhance the Spear PV solar portfolio. We've added one new system to the portfolio. We've also expanded on two of our sites, which have been completed within the first 6 months of the year. We now have 60% of Spear assets covered in solar -- PV solar infrastructure. All of these systems do remain grid-tied and we've been enjoying improved performance of these PV solar systems due to the fact that there has not been any load shedding. Currently, 25% of the total portfolio energy needs are generated by the Spear PV solar portfolio. It is our intention that for FY '25, we aim to produce 10.5 million kilowatt hours of electricity generation from our PV solar portfolio. And this is in addition to the planned integration of the Western Cape Emira assets into our PV solar platform, which will see probably another 1.5 megawatt of capacity coming on stream, to take us to the strategic objective to get in excess of 10 megawatts of PV solar infrastructure on the Spear portfolio. Currently, we are in the feasibility stage of three weeding projects with the city of Cape Town, as we jointly believe that it's important for us to all pioneer towards ensuring energy security for the metro and for the province. In terms of Spear's development growth, we are actively busy finalizing our bulk infrastructure in George, as Phase 1 of the bulk infrastructure work commenced in October 2023. We have a total developable area of 30,000 square meters across 8 sites, and this will be a tenant-driven development, of which we are in advanced negotiations with end users to take up space. But again, this is tenant-driven, and we will not take speculative development risk within the Spear portfolio. We are also in the final stages of planned approval for the expansion of Bravo Park in Blackheath of an additional 7,000 square meter warehouse which also will be tenant-driven. And just given the activity across the SA sector, but specifically in the industrial sector within Cape Town, we believe that this particular warehouse will be tenanted in the not-too-distant future. Moving on to our salient details. Spear owns 27 high-quality Western Cape assets with a portfolio value of ZAR 4.19 billion. Post the implementation of the Western Cape Emira portfolio, Spears assets under ownership by December would be in the region of ZAR 5.3 billion. Portfolio value has decreased from FY '24, as a result of the disposal of the Liberty Life Building and 142 Edward Street, and therefore, you will see a decrease of 9.41%. Our average property value is at ZAR 152 million. Our average property value per square meter is at ZAR 10,174 square meter. Which is maybe something just to mention, that as an investor, you can get access to high-quality Western Cape real estate, giving you a sustainable income at an entry point of ZAR 10,174 square meter, which is way below replacement on a diversified portfolio basis. And given the fact that there's limited land opportunity and increased construction costs, we feel that this is a great value proposition and reflective of a good investment opportunity. Our average in-force escalation is at 7.47%. Portfolio GLA as at the year-to-date, 405,709 square meters with a portfolio occupancy rate of 95%. As mentioned earlier, our weighted average expiry is 26 months. It's always our intention to try and drive up the lease expiry profile of the business to as high as possible. But as many of you know, that for us, it's about tenant preservation and rent preservation. Having a vacancy in the portfolio is a lot more costly than maybe negotiating a slightly shorter lease, which could be an opportunity to renew that lease on better terms within a shorter space of time. Our internal target is to get to between 36 and 45 months as a business. On average, our rental rate per square meter is ZAR 99.36 on a gross basis. Just to granularize our collections for the half year, we collected 95.17% of our rental. Just a reminder of the large power user recovery process, as mentioned earlier. On an industrial basis, we recovered 94.19%; on a commercial basis, 96.28%; and on a retail basis, just under 93%. Moving on to the financial snapshot. Management is still firm with the view that our proposed payout ratio will be 95%. Spear's AREIT cost-to-income ratio is 45.65%. Our admin cost-to-income ratio is at 6.02%. Spear's tangible net asset value per share is ZAR 11.66. That has decreased by about 1.1%, and post the year-end as a result of the disposal of the Liberty Life Building and 142 Edward Street. Robust loan to value at 25.65%. And again, our strategic band is to operate at between 38% and 43%, so we are below that band. But again, we don't believe in having a lazy balance sheet. So once the implementation of the Western Cape Emira acquisition takes place, and the disposal of 100 fairways is finalized, that loan to value would probably operate at a range of around 38%, 39%, which we believe is optimal. Spear's fixed debt ratio is at 84.2%. Our average debt expiry is at 25.45 months. Our average cost of debt is at 9.45%, and average cost of fixed debt at 9.09% and the average cost of variable debt is at 10.13%. So moving along to our letting activity. For the period, we had expiries and vacates of 48,035 square meters. We renewed and relet 49,642 square meters, which is a net gain, not just in GLA, but also at the gross new rental that implemented versus expiry was ZAR 5.1 million versus the gross new rental of ZAR 5.5 million. One will note a slight negative reversion on the commercial portfolio at 1.22%, which we will obviously make work off to try and get us closer to a flat with positive growth as we navigate through the year. Industrial, we did have a vacate, which we haven't relet at this point in time, which resulted in a negative 4.28% reversionary impact on the industrial portfolio. And retail printed a positive 5.86% reversionary profile, which gives us on an average basis, a 4.51% positive rental reversion for the year-to-date period. Having a quick look at the balance sheet and funding. In terms of our covenants, our strictest covenant is on LTV is 50%. As mentioned, we're currently at 25.69%. Our interest cover ratio covenant is 2x, and we are currently operating well within all of our covenants at just under 3x ratio. On the right-hand side of the slide, you'll see our funding update for July. We've seen an improvement in the majority of our funding metrics. Also, we have and will be seeing a further improvement in group average cost of debt once the Emira acquisition has been implemented, given the fact that we negotiated a very favorable debt package on that transaction, which will actually have a downward pressure effect on the total average cost of debt for Spear going forward. Just getting into the sectoral performance. Our Spear's portfolio has continued to display resilience across the board. On a segmented basis, we can see how the operational conditions have improved and how each asset type has performed, over the period. In terms of retail, which comprises about 12% of the portfolio, just under 47,500 square meters, occupancy has increased by 127 basis points from FY '24 to 96.81%. Collections of just under 93%. We saw a positive reversionary print of 5.86% with an in-force escalation of 7.48% for the period. As mentioned previously, trading remains consistent within the convenience retail portfolio and destination retail portfolio that Spear owns. And we've seen that nationals are allocating capital to the expansion of stores. And for us, there's also a great credit risk underpin, because 41% of our tenants are nationals, and we look forward to seeing how the increased CapEx spend and increased footprints will continue to improve and impact the Spear retail portfolio. Having a look at the commercial portfolio, Maxvalu 26% of the total portfolio at 105,343 square meters. Occupancies at the half year had increased by 587 basis points from FY '24, we were at 84.37% occupancy rate. That has increased to 90.24%. Collections at 96.28%, reversions at slightly negative, 1.22%, in-force escalations at 7.39%. As mentioned earlier, we have seen very strong letting activity within the commercial office portfolio on a year-to-date basis with in excess of 9,000 square meters of office space let within the Spear portfolio, during the period. All of Spear's large occupier spaces have been occupied and are fully let. We've seen that international companies, BPOs and large occupiers, users have continued to create a presence within the CBD of Cape Town and within the established office nodes of Cape Town. And this has certainly mitigated what was potentially a vacancy overhang, which never took place. But encouraging now as the economic activity picks up the positive impact of the elections, the formation of the GNU companies are now looking at expansion opportunities, and we will be the net beneficiary of those expansion opportunities, as we continue to navigate through this year. Our 100 fairways close is 100% let. #2, Long Street has increased from FY '24 having a 78% occupancy rate to a 91% occupancy rate. #2 Long Street is a high-rise Cape Town CBD office building in the heart of the financial district and we have continued to see increased activity from the 200 square meter office user all the way through to the 800 square meter office user letting up space with us at 2 Long Street. When we look at the industrial portfolio, making up 62% of total portfolio GLA at just under 253,000 square meters. Occupancy at 96.64%, collections at 94.91%, reversions, negative 4.28%. And as I mentioned, this was due to a nonrenewal vacate that took place, but we are currently in negotiations to let up that space at an improved rental than what it was at expiry. We maintained a robust in-force escalation rate of 7.6%. Again, the assets that we own within our portfolio are well located, they are versatile assets, and have also been the drivers behind the high occupancy rates within the industrial portfolio, as strong demand continues to persist for our multi-let parks and also our larger occupier spaces. The Airport Business Park development within George continues as we finalize the bulk infrastructure for GTX Park Phase I. Just having a look at the general business update. Now as I mentioned, the operating environment does remain challenging, but we have seen real signs of improvement and real reasons to be optimistic. The government of National Unity has been good for business all around. The core portfolio continues to trade within the key operational milestones that we've set out and that we want to achieve for this portfolio. Our office portfolio leasing momentum has been strong on a year-to-date basis. And even beyond the end of August, we are seeing consistent demand for office space across the Spear portfolio, which is encouraging. We will continue to implement our PV solar strategy and water augmentation strategy across the portfolio in addition to the onboarding of the Western Cape Emira portfolio. which will see Spear investing an additional ZAR 20 million to unlock another 1.5 megawatt of solar capacity within that additional portfolio. Rent collections have been in line with forecasts. Receivables have been at acceptable levels. We have seen, as mentioned, some stress in the SME space, but we do believe that the tapering of the interest rate cycle, no load shedding and the prospect of increased growth in the economy, will start to mitigate some of these pressures that are in tenants. We continue to look at portfolio enhancement opportunities across the portfolio as we unlock our embedded bulk, both in Pardon Island, in Black Heath and in other parts of the portfolio, so we can create additional shareholder value across the Spear value chain. So moving along to our outlook. As a management team, we remain optimistic about Spear's FY '25 outlook and the prospects as the trading conditions, and the macroeconomic environment continue to notably improve. Markets are challenging, and there is no getting away from that. However, the green shoots have emerged, they are accelerating, and we do believe that we can summarize the half year as follows. We've seen notable success in active vacancy reductions, which will have a positive impact on profits. There's been no shedding reprieve, which would have a downward pressure on operating costs and also would have a greater performance output of our PV solar portfolio. We're seeing the topping out of the interest rate cycle, which would positively impact the finance cost line item within the income statement. The positive rent reversion prints on a portfolio level will continue to drive top line revenue growth for the business. Our sub-30% loan-to-value and a just shy of 3x interest cover ratio will give Spear and the management team greater optionality to pursue growth opportunities within the Western Cape. And our acquisition-led growth strategy is paying off. We've been patient as a management team, seeking the right deals, at the right time, with the right returns as we are now on the doorstep of the implementation of the Emira Western Cape portfolio acquisition. I believe that the above displays strong key performance outcomes for the first half of FY '25, and we are optimistic and confident that we can build on the momentum that's been created in this half year. As a management team, we are confident that our FY 2025 strategic objectives will continue to be achieved to the benefit of Spear and all of our stakeholders, resulting in a positive outlook for the remainder of FY '25. As a management team, we are firm with the view that the IPS growth will be achieved in FY '25 and we will provide further -- our full year guidance and our half year results presentation to be held in October. This brings us to the end of the presentation. I thank you for joining us today, and we will be back shortly myself and our CFO, Christiaan Barnard, to take any questions. Thank you very much.

Welcome back to the Spear HY 2025 pre-close Q&A. I'm joined here by Spear CFO, Christiaan Barnard, and we are going to just -- there's two questions that have come in from [indiscernible] Wealth, Taylor Ginsberg has asked the following questions. And we'll keep monitoring just for a few seconds after we answer these questions in case any other questions come in. But as always, as a management team, we remain highly accessible. And if you have any further questions, you have the channels to reach out to us, alternatively [email protected]. Thank you.

The first question from Tales. Are you looking to acquire any new assets? And if yes, which sector do you want to expand into higher retail, commercial, logistics, et cetera?

Yes. So strategically. It's -- we kind of have a first-things-first principle. So we've made the acquisition of the Western Cape Emira portfolio. That is now in its implementation phase. Consists of 13 assets of just under 94,000 square meters. We are team that wants to implement this transaction in the right manner. So we don't want to be overly stretched in that sense of just looking for further acquisitions while that's taking place. So we want to do a good job onboarding that portfolio. Once that portfolio has been stabilized into the Spear asset management platform, then certainly, we would look to increase our acquisition action, specifically within the industrial and convenience retail subsectors. We also have stated that we would like to expand our portfolio investment strategy to data centers. But that is a future-dated opportunity as and when it arrives. But within the industrial subsector, we'll invest into logistics, warehousing, manufacturing, urban logistics, multi-let industrial parks, medium, small and large-scale industrial real estate solutions and then within the retail space, as mentioned, convenience retail assets.

Second question also from Talos. What is the average cap rate that you have used in your valuation -- so King of dose valuation. So currently, our intervaluations are in process, so we don't have that specific number yet. But if you do refer to Page 95 of our integrated report for FY '24, you would note the table disclosing the cap rates, exit cap rates, discount rates, all the information. But across the portfolio, the average cap rate was 8.76% and average exit cap rate was 8.8%. Then there's another question that came in from Copano at Mazi Capital, both the disposal and EMI acquisition, where that's your LTV land? What is the long-term sustainable LTV for spear?

So post the disposals and the Emira acquisition, the LTV will land at between 38% and 39%. We want to make sure that we don't have a lazy balance sheet. We also want to make sure that the balance sheet is not overly stressed. So operating at between 38% and 43% loan to value at any given time, which is also dependent on where we find ourselves within the interest rate cycle would be the strategic band upon which -- where we would like to operate.

If I may add, we also prepared a detailed category 1 circular disclosing this information to show, which obviously is previously to any included favorable adjustments at the interim stage. Given the significant reduction of vacancy improved rentals we've seen, we do expect some positive momentum in valuations. We will further bolster the LTV, pressing it lower towards the 39% to 38% at interim stage. And that is it for now.

Thank you very much. This brings us to the end of our HY 2025 pre-close presentation. Thank you for attending the presentation today. Thank you for your ongoing support. And we'll see you in October. Have a great weekend.