Vital Healthcare Property Trust (VHP) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Vital Healthcare Property Trust Half Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Aaron Hockly, Fund Manager. Please go ahead.

Thank you. [Foreign Language] We are very pleased with the detailed Vital's results for the 6 months ended December 31, 2020, a period of significant achievement, including increased earnings, ongoing portfolio improvements, developments continued and commenced, our potential development pipeline increased, gearing reduced and debt extended. These achievements have enabled a distribution guidance upgrade for the second half of this financial year. I will provide a short overview of Vital and some highlights from the half year. Richard Roos will provide a portfolio update, including extensive leasing and asset recycling. Chris Adams will provide an update on Vital's current development pipeline, which was expanded during the half year as well as provide an overview of the potential development pipeline being actively considered. CFO, Michael Groth, will detail Vital's financial performance during the half and our recently agreed debt facility extension. I will conclude with some comments on Vital's outlook before taking questions. As with recent presentations, please note that due to travel restrictions, my colleagues and I are in 4 separate locations. We apologize in advance if there are any technical issues. Vital's portfolio was valued at $2.25 billion at 31 December, up from $2.09 billion at 30 June. Vital has increased its exposure to New Zealand to $643 million or 28% of the total portfolio. This is up from $492 million and 24% at 30 June, following ongoing development at Wakefield Hospital in Wellington and Royston Hospital in Hawke's Bay as well as asset recycling within the portfolio and property revaluations. The remaining $1.61 billion, representing 72% of the portfolio, is split across all mainland states of Australia. A majority of Vital's income is expected to continue to come from Australia, but New Zealand remains an important part of Vital's focus, primarily due to property fundamentals. We also note that a majority of our investors are located here, and many of our investors are attracted to Vital as it enables them to direct their savings into the health ecosystems of their communities. Vital's ownership structure has not materially moved during the half, with NorthWest continuing to hold just over 1/4 of Vital's units and the balance held by a mixture of retail and institutional investors, primarily based in New Zealand. This is despite a capital raising and a favorable IRD ruling during the half, which enabled NorthWest to receive its incentive units -- incentive fees and units as envisaged under Vital's Trust fees. NorthWest is in the process of developing a sustainability framework, encompassing the environments, people and governance. This framework will include Vital, and we will look to provide more detail as part of our full year results. With our 30 June results, we provided an overview of Vital's portfolio strategy. The asset recycling, leasing and developments undertaken during the half year are all consistent with this strategy and are expected to help ensure Vital achieves its medium-term target of growing AFFO by 2% to 3% per unit per annum. We continue to evaluate a number of opportunities for Vital consistent with this strategy. I would like to reiterate previous comments that we aren't seeking to lower Vital's exposure to hospitals per se, but we expect the proportionately more opportunities for Vital will be from the other subsectors, having regard to our overall strategy and market opportunities. Over $230 million of capital transactions were undertaken during the half year. This equates to over 15% of the portfolio's value being recycled, principally through the sale of 3 assets and 1 acquisition, which I will speak more about shortly. Over $170 million of new equity was raised by replacement in UPP as well as 2 DRPs, which had a 46% participation rate. This helped to lower balance sheet gearing to 32.4% at 31 December and provide support for future value-enhancing acquisitions and developments, including providing funding for the existing development pipeline. Post balance date, terms were agreed to extend and diversify Vital's banking syndicate, thereby removing Vital's previous debt maturity in March and taking Vital's weighted average debt maturity to 2.9 years at 31 December. This is still below where we would like it to be and work is underway to address this. Three regional Australian assets were sold during the half for over $100 million, nearly 15% above their book value. Vital had extracted the maximum value it could from these assets, and the sales were in accordance with our strategy of continually improving and upgrading the portfolio across a range of metrics, including WALE, building age, location and tenant diversity. The sale proceeds were used to acquire Grace Hospital in Tauranga, which Richard will talk more about shortly. Notably, Grace Hospital has a 30-year WALE, double that of the disposed assets as well as a future development program we are currently working on with the tenants. This asset recycling plus leasing and developments has improved the overall portfolio, including a reduction in single-tenant exposure from 48% to 41%, an increase in metropolitan assets from 71% of the portfolio to 76%, a reduction of average building age from 12.1 years to 11.9 years and an increase in Vital's WALE from 18.1 years to 19 years. Future capital recycling will be considered to fund new acquisitions or developments, and we have identified a number of assets for potential disposal in the future. Rent reviews conducted during the half had an average increase of 2.1%. This demonstrates the resilience of health care assets. Overall earnings growth was 7.5%, including foreign exchange impacts, reflecting rental growth, acquisitions and developments. Nearly $60 million of development expenditure was undertaken during the half, and over $60 million of new developments were commenced. At 31 December, 2020, Vital had 9 developments underway with the total cost projected at close to $360 million, of which $225 million is left to complete. In addition, we have a potential development pipeline of over $560 million, which is being actively considered, including over $350 million in Melbourne, following an acquisition in December, which Chris will talk more about shortly. This potential pipeline will ensure that Vital continues to have 10% to 15% of the portfolio under development, with new developments available to replace existing ones as they complete. To the extent we proceed with any part of the potential pipeline, it would be completed on a stage basis over the medium term. There is no guarantee that any of the potential pipeline will become committed developments, but we are aiming to be as transparent as we can on the longer-term future for Vital. We will update the market if and when potential developments convert to committed. Vital's balance sheet was strengthened over the half by equity raisings and property revaluations with gearing reduced to 32.4% at 31 December, down from 38.7% at 30 June. This provides capacity for future value-enhancing acquisitions and developments. NTA per unit increased by 7.1% over the half reflecting property revaluations, retained earnings and raising capital above NTA. Despite COVID-19, Vital's defensive portfolio helped to record a 19.8% total return for the 12 months ended 31 December 2020. This was 15.4% above the NZX REIT index and 5.9% above the broader NZX 50 index. For the 10 years for 31 December 2020, Vital recorded a 17.6% total return per annum, outperforming both the REIT index by 4.5% per annum and the NZX 50 index by 2.9% per annum. This outperformance highlights Vital's defensive characteristics, including its market-leading 19-year WALE and earnings growth. Vital's portfolio of health care assets continue to outperform the core real estate asset classes of office, retail and industrial, particularly over the last 5 years, taking into account both income and capital growth. On that note, I will hand over to Richard Roos to discuss Vital's property portfolio in more detail.

Thank you, Aaron, and good morning. Turning to the portfolio overview section, starting on Slide 14. The Vital portfolio is made up of 4 key asset groupings, and all of them are performing well. Our portfolio of 16 private hospitals in Australia are leased to 4 hospital operators and represent 58% of portfolio value and 54% of rent on a weighted average lease term, or WALE, of 20.4 years. In New Zealand, we have 9 surgical hospitals in partnership with 6 operators, representing 25% of the portfolio by both rent and value on a WALE of 22.3 years. Vital owns a total of 9 outpatient or medical office buildings, 6 in Australia and 3 in New Zealand. These assets represent 11% of the portfolio's value and 12% of its total rent on a WALE of 8.9 years. The fourth key asset grouping is aged care with 8 assets all located in Australia, leased to 2 operators on a WALE of 15.6 years. I am pleased to advise that while all of the asset groups performed well during the challenges of the past 12 months, no rent abatements or deferrals were requested or provided to our aged care operators. This speaks to the capable management of these facilities by our operator partners under difficult circumstances. The portfolio was further strengthened in the first half of FY '21 by the reduction in its single-tenant exposure from 48% of rent to 41% through a combination of the sale of 3 regional Australian assets at $12.9 million above book value and the acquisition of a major New Zealand hospital, which I detail later in the presentation. On Slide 15, we've seen 7.5% growth period-over-period in net property income, or NPI, which excludes a further 1% gain due to foreign exchange movements for a total NPI growth of 8.5%. In dollar terms over the past 12 months, NPI grew from $49.9 million to $54.2 million. This increase was a result of $2 million in income from net new acquisitions, $2.1 million from completed developments, $620,000 from rent reviews and $523,000 from a favorable movement in FX. From these gains, we deduct the following amounts: repairs and maintenance and leasing costs totaling $783,000; and minimal abatements of rent totaling $124,000, which is a reflection of the strong levels of government support for private hospitals and the inelastic nature of demand for health care. In good economic times and in difficult times, our health care tenants provide a service that people need, not choose. Leasing activity in the first half of FY '21 was also very strong with Healthe Care committing to a total of 24.5 years of additional lease term across 4 hospitals. This included 2 of the regional hospitals, which were then sold at a substantial premium to book value, partially as a result of the longer lease term. Turning to Slide 16. At the end of June 2020, the total value of the portfolio was $2.9 billion. Six months later, the portfolio value had increased 8% to $2.225 billion. This growth was made up of $135 million of acquisitions, less the $88 million in book value from the sale of the 3 regional hospitals, plus $57 million in capitalized development costs for projects that have not yet completed; and an increase of $61 million due to property revaluations, of which $55 million was due to 20 basis points of cap rate tightening since June 30, 2020. The increase in revaluations is based on 35% of the assets being independently valued at 31 December, with the balance of the portfolio to be completed at 30 June 2021. The revaluation gain demonstrates that well-leased health care assets continue to experience increases in value through cap rate compression. On Slide 17, we are pleased to provide detail on this largest single acquisition by value ever undertaken by Vital. The $95 million acquisition of the Grace Hospital in Tauranga was settled on an initial yield of 5.25% in December of 2020. This high-quality hospital is leased on an initial 30-year term to a partnership between Southern Cross and Evolution, the first and third largest private hospital operators in New Zealand. The hospital currently has 51 in-patient beds and 11 operating theaters, with plans already underway for an expansion of up to $50 million. At a value of $95 million, Grace Hospital is the sixth largest asset by value in the Vital portfolio and the second largest in New Zealand, second only to Ascot hospital with a value of $123 million. Post the planned redevelopment, Grace would be the third most valuable asset in Vital's portfolio, exceeded only by the Epworth Eastern in Melbourne and Lingard Private in Newcastle. I will now turn the presentation over to Chris Adams, Executive Director, Development.

Thank you, Richard, and good morning all. Slide 19. As noted by Aaron as part of his comments, the development strategy for Vital reflects the commitment to support the growth of our operating partners via development, capturing business opportunities and growth along with upgrading of infrastructure quality. In turn, supporting the underlying financial performance of the fund by accretive developments, which are currently running at a return on cost of circa 6.1% growth across the book. First book of developments currently sits at $356 million of projects in construction with an expanded future pipeline of $560 million. Importantly, all active projects remain on plan, with strong risk management being a key component of the overall development business for Vital. Slide 20. The acquisition of 17 to 23 Nelson Road highlighted in yellow on the slide marks a key milestone for Vital in what is more than a 20-year journey to date in Box Hill with Eastern. This area, which has undergone extensive development by the public and private sectors over many years and is clearly positioned as one of Melbourne's leading health and education precincts. The Nelson Road acquisition followed a complex process to include Box Hill Public Hospital, Box Hill Institute, Epworth and the Salvation Army to secure a very strategic landholding that provides for the development of over 40,000 square meters over time. This development will occur on a stage basis, with the first step being to master plan the long-term growth of the Epworth with Eastern Hospital, which will commence shortly. Thereafter, the scheme will be shaped to include other key health and education uses, including life sciences. Importantly, the site has the benefit of holding income via lease to Epworth, whilst the development is shaped and delivered over time. On to Slide 21. This slide reflects another key medical precinct development for the fund at Playford Health Hub in the northern suburbs of Adelaide. The project is co-located with long Lyell McEwin public hospital, the third-largest public hospital in South Australia and the public facility in the state with the strongest growth in demand for services. This project is being delivered in stages with the first stage now under construction, representing a circa $20 million spend. It provides amenity for the overall precinct by the relocation of existing retail on-site and a carpark building to support the Stage 2 medical office building and the Stage 3 hospital. Over 50% of the car park representing 250 parking base a lease to SA Health as part of their parking requirements for Lyell McEwin. Positive discussions continue with key medical groups to occupy Stage 2, including Calgary, a major cap at hospital group, who are also active in their business case to relocate their central district hospital to the site as Stage 3. Slides 22 and 23 show key projects with healthy care, Vital's largest tenant and a group with which we have a long history of brownfield development. These projects are at Belmont Private Hospital in Brisbane and Abbotsford Private Hospital in Perth. Both of these projects have been recently attended with tender outcomes in line with expectations. Construction has commenced at Abbotsford with BADGE Construction, an experienced health care builder and will shortly commence at Belmont with the selection of the contractor pending. These hospitals provide key mental health services to their communities, with business cases reflecting strong demand for services from these leading facilities. Slide 24 summarizes the overall development book of committed projects in further detail. As noted earlier, at $356 million. All projects remain on track despite the implications of COVID on various construction markets. For many projects, this has resulted in extension of time claims and additional costs associated with increased PPE and social distancing. However, these costs have been absorbed within project contingencies. The greatest COVID impact is at Eden Rehabilitation on the Sunshine Coast. With the project now being delivered on a stage basis following the decision not to commence on the original project start date until the implications of COVID were better understood. Key projects at Epworth Eastern in Melbourne and Wakefield continue well, with Epworth Eastern now at Level 8 of the 14-level tower. Increased scope of Wakefield, including via a large award, has resulted in an additional spend of circa $12 million for the overall project. Stage 1 is moving to completion in May of this year. We are pleased to report the completion of South Eastern Private Hospital in Melbourne, and the main hospital works at Royston in Hastings in recent weeks. Overall, to summarize we believe the development projects and future book is well positioned to deliver on the development component of Vital strategic plan. I will now hand over to Michael Groth, the Group Chief Financial Officer.

Thank you, Chris, and good morning. Now turning to Vital's financial results and capital management. On Slide 26, we summarize Vital's financial results for the period. Statutory profit before tax was up strongly to $103.2 million or 50.7% versus the comparable period last year, off the back of significant property valuation increases following cap rate compression, as reported by Richard earlier, and a strong increase in operating profit. Operating profit is up 19.6% to $28.2 million versus the prior comparative period, driven by a strong 8.5% increase in net property income to $54.2 million, with the major contributors to this result being same-property net income growth of 1.5%, reflecting the structured fixed and CPI rent increases that are a feature of our portfolio; a full contribution from property acquisitions completed in the second half of FY '20, plus increased rent from Belmont Private Hospital; and the 50% of Playford Health Hub acquired in the current period; income from completed and ongoing development projects, including the Lingard Day Center, the Hills Clinic and Wakefield Hospital. Net finance costs were also down, predominantly due to a reduction of about 40 basis points of Vital's all-in cost of drawn debt compared to the same time last year. This strong operating profit result has underpinned reported adjusted funds from operations, or AFFO. AFFO increased 20% to $0.0587 per unit. And for our analysts and brokers, Slide 37, provides a full reconciliation of this to our reported operating profit. Distributions to unitholders were in line with guidance, we remained steady at $0.04375 per unit for the half. Vital's balance sheet, as set out on Slide 27, was further strengthened in the current period with $157.5 million in new equity raised, ensuring that the group remains in a very healthy position. This is further enhanced by the attractive fundamentals of the health care property sector that has shown its resilience and proven its credentials throughout the recent COVID-related challenges. Borrowings fell almost $80 million for the half, as the equity raise proceeds have initially been applied to debt repayment, partially offset by development in other property-related expenditure incurred. A highlight of the period is Vital's significant improvement in its debt to gross assets ratio. This ratio fell 6.3 percentage points in the half to 32.4%, providing significant capacity to complete Vital's committed development pipeline and additional ongoing flexibility to deliver on its strategic objectives and value for investors. Both unitholder funds and units on issue have increased following the October equity raise, increased participation in the dividend reinvestment plan and the August settlement of the manager's incentive fee. Net tangible assets per unit is up 7.1% to $2.55, and Slide 28 sets out the key drivers underpinning this game. This includes the strong property revaluations reported and realized asset disposal profits, combined with the completion of the equity raise as a premium to NTA as discussed by Aaron. Skipping to Slides 29 and 30. It has been a very active half for the group on the capital management front. One was focused on refining and optimizing our capital structure to ensure Vital is well positioned for growth. I am pleased to report that we have now delivered on the first 2 stages of Vital's previously announced debt strategy. Enhanced flexibility and improved terms for our lending arrangements have been agreed, most notably with an increased loan-to-value ratio covenant of 55%, designed to provide clear headroom to Vital's trusted covenant. In addition, financing arrangements have transitioned to a common terms deal with bilateral pricing structure that now delivers a straightforward way of introducing new financiers to the group to achieve maximum competitive tension. On the refinancing and term extension front, we welcome 3 new to group finances who had, in aggregate, committed $320 million and $75 million of Australian dollar and Kiwi dollar facilities, respectively, predominantly on 5-year terms, delivering an overall limit increase of approximately AUD 40 million. As a result, Vital's pro forma weighted average debt term to maturity will increase from 1.3 years to 2.9 years, with the next maturity scheduled for November '21. These improvements to our lending arrangements and the appetite expressed from our new financiers represent a strong endorsement at the group and its strategy. Our capital management priorities for the remainder of this financial year now turn to securing long duration debt for the group. I will now pass you back to Aaron to take you through our outlook and wrap up.

Thanks, Michael. [Foreign Language] On Slide 32, we break down the value-added for unitholders over the last 6 months and beyond. Focusing on the numbers per unit compared with the prior corresponding period, net property income increased by 2% and expenses decreased by 7.3%, leading to a 12.4% increase in operating profit per unit. After adding the significant capital gains across the portfolio, total unitholder profit increased by 50.5% per unit from the prior corresponding period. Health care property remains a defensive asset class, underpinned by growing demand, high levels of government support in Australia and New Zealand and growing institutional interest. Notwithstanding the challenging health and economic environment due to COVID-19, Vital remains well positioned to continue to grow earnings, achieve our revised distribution guidance and continue to improve Vital's high-quality portfolio. We remain focused on growing earnings per unit, and our portfolio strategy, acquisitions, developments and capital structuring are all designed to support this. The primary measure we focus on is AFFO per unit, which rose 20.2% from the prior corresponding period. Despite COVID-19, over 99% of rent was collected for the half, enabling us to meet distribution guidance for the first half of $0.04375 per unit, an increased guidance for the second half to $0.045 per unit or $0.09 on an annualized basis. We anticipate that the payout ratio will remain conservative at around 80% for this financial year. As noted earlier, Vital has a significant existing development pipeline as well as a significant potential development pipeline. Both the committed and potential pipelines increased during the half, and we expect that developments will continue to play an important role, providing both earnings and capital growth as well as continuing to improve the overall portfolio. NorthWest has unmatched sector expertise, which Vital will continue to capitalize on. We will continue to review asset sale opportunities as a means to fund future acquisitions and developments. Later this calendar year, we will look to diversify Vital's sources of debt as well as further expanding the debt tenor. Finally, as mentioned earlier, NorthWest is in the process of developing a sustainability framework, which will include Vital. We will provide more details as part of our full year results in August. We will now take questions.

[Operator Instructions] Your first question comes from Arie Dekker with Jarden.

The first question, just what's driving the conservative approach on AFFO payout ratio? And I mean what would be the conditions under what you'd sort of review that and perhaps lift it?

Thanks, Arie. I'll hand over to Chris.

Yes. So Arie, I think we're pretty comfortable where we're at on that payout ratio. That's something that we make sure that we focus on to ensure that it delivers a sustainable distribution growth potential of the group. We're obviously looking to raise distributions over time in that 2% to 3% per annum, but that payout ratio that Aaron was explaining before is about 80%. It's something that the group feels pretty comfortable about.

Right. And then just the only other one from me is a very clear presentation. The material net capitalized incentives during the period, just over $30 million. Could you just give a little bit of color on what they are? And then also whether we should sort of expect any sort of repeat of capitalized incentives of that sort of magnitude in the next couple of years?

Okay. I'll take this one again. So that's a one-off nonrecurring feature in the current half. So let's be very clear about that. It was an opportunity to rebase rent on one of their major assets around the group in exchange for a material increase in lease terms, so it's the Belmont Private Hospital. And so it was a deal that was pretty essential and compelling to do for the group at the time. Like I said, it's non reoccurring, and it's not a feature as the portfolio.

So there was a 10-year lease extension on that asset. What was the extent of the rental uplift?

So the rental uplift was effectively about $1.5 million a year.

Okay. Because in the context of Belmont's value at around, I think it's at $120-million-odd, that does seem like a high amount.

Yes, Arie, it was a bit more expensive. Belmont was a primary extension, but we also extended leases at 2 assets that were divested and had a range of other portfolio-enhancing measures that we're undertaking. I think we spoke about that as part of our quarterly updates, but I'm happy to provide you more detail. It's just more complicated than just one number.

[Operator Instructions] Our next question comes from Rohan Koreman-Smit with for Forsyth Barr.

Hopefully, a couple of quick ones for me. First, just following up on Arie's. Slide 15, your leasing activity actually reduced net property income. Can you just square that away with the comment you made around Belmont delivering, I guess, $1.6 million more?

Sorry, Rohan, can you just repeat the question?

So Slide 15, leasing activity, $25,000 reduction. And you said Belmont delivered $1.6 million more rent because the rent was rebased, so half of that $800,000, but I'm guessing you had some other negative leasing activity in the period or maybe, I guess, the net outcome wasn't as great as you just described.

Yes. So there's probably 2 important things to note in that. So the acquisitions number of $2.1 million on that slide includes the rent rebasing on the Belmont property that we're just talking about. So that was a transaction that occurred partway through the period. And that's why you're not seeing the full impact of that come through. So I think that answers your question.

Yes, yes. Sure. That certainly does. So it's just in a different bucket is what you're saying.

That's right. That's right. And so you can see that the rental impact is really about $617 million, which is next to that. We've treated the Belmont transactions, et cetera, as a capital transaction and increased the previous slide as a result.

Okay. Can you just give me some color around, I guess, what is your definition of a lease incentive or a noncapital transaction because, I guess, securing market rent and increasing lease term seems like standard leasing for me?