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

Thank you for standing by and welcome to the Vital Healthcare Property Trust full 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] Welcome to Vital's FY '21 results call. My name is Aaron Hockly, Fund Manager of Vital Healthcare Property Trust. With me today is CFO, Michael Groth; as well as Richard Roos, Executive Director of Portfolio; and Chris Adams, Executive Director of Developments. Together, we will run through the highlights from another very successful year and provide an opportunity for questions at the end of this call. Please accept our apologies in advance if there are any technical issues, noting that we are dialing in from 4 separate locations. Full details of our governance arrangements, strategy and portfolio are available on our website, bhpt.co.nz, where you will also find our contact details should you require them. During FY '21, we continued to deliver on our strategies to develop and grow our unique healthcare portfolio in Australia and New Zealand, whilst providing significant growth and returns for our unitholders. Vital's portfolio of assets and its key metrics, including a market-leading WALE of 18.7 years, are unmatched in a listed vehicle in Australia or New Zealand. As a result, Vital remains a unique investment proposition. With our FY '20 annual results, we released details of Vital's 5-year portfolio strategy, which we have continued to deploy. This strategy helped us deliver earnings and distribution growth in FY '21 and increase earnings and distribution guidance for FY '22. AFFO is expected to grow from $0.1045 per unit in FY '20 to $0.118 per unit in FY '22, an average of 6.3% growth per annum. Similarly, distributions are expected to grow from $0.0875 per unit in FY '20 to $0.095 per unit in FY '22, or an average of 4.2% growth per annum. Continued growth in earnings will be supported by our focus on continuing to maintain and improve the property portfolio, including our 18.7 year WALE, young average building age of just over 11 years and limited upcoming lease expiries. These metrics help us maintain modest CapEx, enabling higher cash returns for our unitholders. We are focused on ways of providing future growth in both earnings and value. As a result, we have continued to focus on our development pipeline, including acquisitions for future development, working with tenants on current and proposed developments, and hiring new employees to support development delivery. Vital's balance sheet was strengthened over FY '21 through $235 million of property revaluation gains and equity raising, noting that approximately 46% of Vital's unitholders participate in the DRP. As a result, balance sheet gearing was 35% at 30 June, 2021, providing significant capacity for our development pipeline. Property revaluation gains, raising equity above NTA and our prudent 76% payout ratio helped NTA per unit rise by 21% over the year. Michael will talk more about our debt strategy and overall earnings profile shortly. Excluding ForEx, Vital's portfolio recorded an 8% increase in underlying earnings for the year, reflecting acquisitions, developments, rent reviews and 60,000 square meters of new or extended leasing. As the bulk of these improvements occurred during the year rather than at the start, Vital only recorded a partial uplift in FY '21 with further uplifts anticipated in future periods. Demands for quality commercial real estate in general and healthcare real estate in particular continued to increase during the year, leading to 66 basis points of cap rate compression. We took the opportunity afforded by this heightened demand to sell $100 million of regional assets, improving the overall portfolio. Growth in healthcare real estate investment demand, particularly in Australia, is expected to continue to provide significant valuation support, particularly for Vital's unmatched portfolio of private hospitals in a listed vehicle in New Zealand or Australia. Richard will speak more about the portfolio shortly. Developments remain a core strength of Vital's manager, delivering significant earnings and valuation upside for Vital's unitholders. On average, developments provide a 6% gross yield on costs. Even after allowing for some leakage from this yield, the net returns detailed on Slide 37 of the presentation released today compares favorably to Vital's weighted average cap rate and cost of capital. Developments also enable us to ensure Vital's portfolio continues to meet tenant and patient demand, given ongoing and expected changes in healthcare. During the year, $80 million of developments completed, most of which comprise Stage 1 of Wakefield Hospital in Wellington which is due to be officially opened this coming Monday. We commenced $74 million of new developments and continued work on both the existing pipeline and our potential pipeline, which Chris will provide more detail on shortly. Of the $286 million of acquisitions announced during FY 2021, approximately $185 million of this was for 2 established hospitals in Tauranga and Melbourne. These acquisitions are triple or quad net leased, limiting CapEx, was sourced from Vital's existing tenants, demonstrating the importance of relationships in the sector and provide nearly $9 million per annum of additional net property income. In addition, we acquired 5 development properties for $70 million in Adelaide, Auckland, Brisbane, Gold Coast and Melbourne. These acquisitions will allow us to continue to deliver new healthcare facilities to communities in Australia and New Zealand, whilst providing earnings growth for Vital's unitholders. Vital's total development pipeline, including potential developments, now totals nearly $1 billion and we are actively working on these projects. Finally, Vital delivered a total return for FY '21 of 27.7%, exceeding both the real estate index and the broader NZX 50. I will now hand over to Richard Roos.

Thank you, Aaron, and again, good morning, everyone. If we turn to the portfolio overview and update, starting on Page 13. As shown on the slide, we have grouped assets in the Vital portfolio into 4 categories to provide a better understanding of the portfolio and its makeup. The portfolio by value is made up of 85% hospitals, 10% medical office buildings and 5% aged care assets. If we break down the hospital assets further, 27% of the portfolio are Australian mental health and/or rehab facilities, and 35% are Australian acute or surgical hospitals on a combined WALE of 19.6 years while 23% of the portfolio are New Zealand acute hospitals on a WALE of 22.4 years. These hospitals are located in major metro centers like Auckland, Wellington, Sydney, Melbourne, Adelaide, Brisbane and Perth, or large and growing regional centers like Newcastle or the Gold Coast, typically with large public hospitals located in close proximity to assist in securing doctors and public health contracts. The key message of this slide is that Vital has a very desirable portfolio of high-quality long WALE healthcare assets, primarily hospitals in premium locations across both Australia and New Zealand, a portfolio that has taken 20 years to assemble and cannot be replicated. Turning to Slide 14. In FY '21, Vital achieved annual growth of 8% in net property income or 9.4% if you include the foreign exchange gains. In dollar terms, over the past 12 months, NPI grew from $100 million to almost $110 million. The increase was a result of $6.1 million in new income from acquisitions, more than twice the amount of income recycled from the sale of 3 regional Australian hospitals, which were sold in FY '21 for a 14.7% premium over book value, $4.4 million of additional income from development rents, $900,000 from rent reviews reflecting a growth rate of 1.8%, and $1 million from favorable movements in FX and other nonrecurring items. Let me touch on a few key leasing activities. During FY '21, we secured a 10-year lease extension to 25 years at Belmont Private Hospital. Belmont, located in Brisbane and operated by Healthe Care, is one of Australia's top private mental health facilities. It is currently undergoing a $24 million expansion, adding an additional 48 inpatient beds and other upgrade works scheduled for completion in late 2022. The redevelopment will include a purpose-built women center to treat more patients affected by perinatal mood disorders and a new adolescent mental health award for patients aged from 16 years. On completion of the works, Belmont will be the second largest private mental health facility in Australia with 185 beds. We were also successful in finalizing a 10-year lease extension with the Hawke's Bay DHB at the Napier Health Center. The extension of this lease to a total of 12.5 years removes the uncertainty around renewal and with the planned seismic upgrade, will add significant upside to the value of the asset. CapEx spend remains modest due to a number of factors, including the long WALE of 18.7 years with minimal lease expiries and therefore, limited refurbishment CapEx. The sale-leaseback nature of the leases typically maximizes the initial capital to the hospital operator by minimizing ongoing landlord obligations. As Aaron mentioned, the portfolio has a young building age due to regular brownfield expansions, which also ensures that major CapEx items are often upgraded as part of a project and then rentalized. Overall, the portfolio is well positioned to continue to deliver strong, stable NPI growth. Turning to Slide 15. At the end of June 2020, the total value of the portfolio was $2.86 billion. 12 months later, the portfolio has increased to $2.635 billion. This growth of $549 million includes $269 million of transactions, substantially more than required to offset the $88 million of capital recycling, an additional $127 million in capitalized development costs for projects under construction and an increase of $235 million in gains from property revaluations. These gains in revaluations resulted from 66 basis points of cap rate compression since 30 June, 2020, $17 million related to rent increases and $30 million of margin from development. New market entrants looking to acquire healthcare assets, drawn by strong demand for healthcare and the infrastructure like-nature of the assets, having stable CPI-linked or better cash flows and long-term leases, continue to drive up the value of healthcare assets, especially best-in-class assets like those in the Vital portfolio. On Slide 16, we highlight Vital's top 5 tenants. The first is Healthe Care Specialty, representing 28% of the portfolio with 10 mental health and/or rehab hospitals, including Belmont Private in Brisbane, which I referred to, Currumbin Clinic on the Gold Coast and South Eastern Private in Melbourne. Healthe Care is one of the largest providers of private mental health beds in Australia, a service which is in very high demand due to the added challenges created by the pandemic. The current Singaporean-based owner is planning to lift the specialty division to be known as Aurora on the ASX in September. The listing would be a positive outcome for Vital as it would enhance Aurora's ability to access capital and partner with Vital on new opportunities. Healthe Care Acutes division. This represents 14% of the portfolio across 4 assets: 2 on the New South Wales Central Coast, one in Sydney and 1 in Lower Hutt. The acute hospitals are also in the process of being sold to PEP, an Australian-based private equity group and owners of evolution healthcare, an existing key Vital partner. Again, this is a positive story for Vital as PEP will be more focused on driving the growth and performance of the Vital-owned hospitals than the current Singaporean-based owners who have multinational healthcare interests. With the recent purchase of Epworth Camberwell, Vital now owns 3 Epworth hospitals, representing 13% of Vital's portfolio. This includes the Epworth Eastern, Vital's most valuable asset, which is currently undergoing a AUD 96.5 million expansion. Epworth is the largest not-for-profit private hospital operator in the state of Victoria. Evolution Healthcare are our partners across 3 New Zealand hospitals, including Royston in Hastings and Bowen & Wakefield in Wellington, and make up 10% of our portfolio. Evolution, as I indicated, is also owned by PEP, who have made significant investments across all 3 hospitals during the 3 years that they have owned the assets. Our fifth largest and one of our newer tenants is an operating partnership between Southern Cross and Evolution at the Grace Hospital in Tauranga, which was acquired by Vital in late 2020. This high-quality hospital has 51 in-patient beds and 11 operating theaters, and represents 4% of Vital's portfolio by value. We expect to commence a circa $50 million multistage development in 2022. Strong relationships with our operator partners are key to delivering on the asset management strategy for each hospital as well as providing off-market opportunities like the recent acquisition of the Epworth Camberwell and Grace Hospital. Thank you. I will now turn the presentation to Chris who will update you on our developments.

Thank you, Richard, and good morning, all. Slide 18. The development strategy for Vital reflects the commitment to proactively support the growth of our operating partners via development, capture new business opportunities and growth, invest in our communities by our enhanced health services, upgrade infrastructure quality and, in turn, support the underlying financial performance of the fund via accretive development. This book of developments currently sits at $312 million of projects as noted by Aaron, slightly down from the half year due to the restructure of the Epworth Eastern project, whereby Epworth are currently funding a greater share of the project. However, the fund has an expanded pipeline of circa $740 million. A key feature of the development strategy and the value-add is the depth of the skill set and experience of the development team having the skills and experience to quickly evaluate opportunities without material expense, manage analysis and feasibility in-house, skills and the creation of the overall vision, including site master plans, execution, procurement strategy, contracting and relationships with key consultants as industry experts in health planning, architecture, building services and environmentally sustainable design, delivery and governance, and overall risk management. Slide 19 notes 2 of the smaller but important projects completed in 2021. At South Eastern, with the completion of a new day oncology unit and ward expansion for $9.2 million. This is the latest in a number of stages at the hospital, which has undergone significant upgrade and expansion over recent years. Early planting is also underway for additional stages following the acquisition of adjoining land. The main hospital works at Royston Hospital in Hastings have concluded at a spend of approximately $10 million with the adjoining $8.1 million day surgery project been well advanced for a late 2021 completion. The Hawke's Bay has seen growth in its population and demand for services. This has also been supported by the relocation of a number of specialists to the region, which is underpinning strong performance at the hospital to support these projects and the likelihood for further development works. Slide 20 summarizes the overall development book of committed projects in further detail, as noted at over $300 million. The projects remain on track despite the implications of COVID on various construction markets. Some key project milestones have been realized or are pending: completion of Stage 1 at Wakefield with the building now in use, awarded the tender for demolition works for Stage 2 at Wakefield and finalization of the Stage 2 contract. Epworth Eastern progressing well with the fit-out of clinical areas well underway with the handover of their building due to occur progressively from November 2021 to be fully complete in early 2022. Projects to upgrade and expand mental health services at each of Belmont Hospital in Perth -- excuse me, Abbotsford Hospital in Perth and Belmont Hospital in Brisbane are now well underway. 2 smaller projects at Eden Rehabilitation on the Sunshine Coast Queensland and Bowen at Wellington have been impacted by changing market conditions and are therefore being staged or are on hold pending review of the business case. Slide 21. In addition to the greater than $300 million of committed projects, Vital has a significant potential pipeline, as noted earlier, at $740 million. These opportunities are spread across a number of key metropolitan cities as outlined are diversified by operator partner and project type, meaning different health subsector uses and procurement types are largely precinct-focused. These projects will replace existing pipeline as projects are completed in upcoming months, including Epworth Eastern, but will remain subject to robust evaluation on a project-by-project basis considering risk management, procurement, tenancy risks and capital management. All of the pipeline projects indicated are based on strategic land holdings on balance sheet such as Playford Health Hub, Ormiston and Box Hill Melbourne, and other sites that are joined existing assets. This opportunity set has been enhanced by the recent acquisitions at Woolloongabba, Brisbane; Currumbin, Gold Coast; and Park Road, Auckland. In summary, we believe the development projects and future book continues materially in line with expectations is well positioned to deliver on the development component of Vital's strategic plan. I will now pass over to Michael.

Thank you, Chris, and good morning. As Aaron introduced earlier, Vital has delivered a strong set of results for the year. Both earnings and distributions are up significantly. And importantly, the foundations to deliver increased investor returns have been enhanced. Starting at Slide 23, finals performance by the numbers is set out. Operating profit before tax and other income was up 24.1%. Adjusted funds from operations was up 10.4% per unit. Unitholder distributions increased to $0.8875 per unit. The AFFO payout ratio was 77%, an improvement on the prior year. We're targeting to maintain this at around 80%. These strong results were underpinned by the defensive characteristics of the healthcare property sector, together with the resolute focus of the manager on executing Vital's strategy to continually add unitholder value. Richard has already touched on the key drivers leading to the 9.5% increase in net property income. I did want to emphasize that almost half of this income growth does come from the delivery of Vital's committed developments. Certain of these like Wakefield are being rentalized as delivered, whilst others like South Eastern become income-producing on completion. In other material movements, management fees were up $6.7 million, reflecting a $6.1 million increase in the incentive fee following strong investment property gains of $235 million, which incorporates a development margin of about $30 million, together with the profits from the disposal of 3 regional hospitals. Corporate reconstruction costs were nil compared to a net $7.5 million expense in the prior year. Slide 24 shows Vital retains a strong and flexible balance sheet, well positioned to support new opportunities to add further unitholder value. Gearing has improved 3.7 percentage points to 35%. This was driven by both the $183 million of new equity raised during the year and the strong investment property gains booked following that 66-basis point timing of capitalization rates to 4.88% on 30 June. Borrowings have increased by about 14% to $932 million as Vital has deployed its balance sheet to acquire future development sites like Nelson Road, which is adjacent to Epworth Eastern, and high-quality income-producing assets like Epworth Camberwell. NTA per unit increased 21.4% to $2.89. And as you will see, to see from Slide 25, investment property gains and development margins net of deferred tax, were the primary contributors to this increase. Slide 26 captures the work that we have done, ensuring that Vital has the right financial foundations to support our core target of delivering 2% to 3% per annum growth in AFFO and distributions per unit over the medium term. By financial foundations, we mean ensuring that Vital has the best opportunity to access attractively priced capital, debt or equity, through an economic cycle so we can pursue accretive opportunities. We have done this by raising equity in October to lower gearing and create balance sheet capacity to commit to new developments and acquire high-quality income producing properties, some of which have further development potential, and by rebasing our borrowing arrangements to introduce more flexibility into their terms, diversify earning sources by adding 3 new banking groups and extending our debt maturity profile. However, there is still more to do. The refinance of our maturing facilities is well advanced. All existing financiers have shown strong support to increase their participation and we are actively working with new and existing banks to provide competitively priced longer term financing. Final credit approvals are expected in the coming weeks. The Board has also recently signed off on Vital's long-term debt strategy, whereby we will be targeting 7- to 12-year term finance by the U.S. private placement or $1 medium term note, institutional term loan markets. We expect to have launched our inaugural issuance by December, delivering on our objective of increasing the alignment between our long duration property cash flows, and the term and cash flows of the debt that in part finances these properties. On Slide 27, we have provided a snapshot of the bank facilities in key metrics at 30 June. Importantly, we have more than sufficient limits in gearing capacity to support Vital's growth opportunities. It is also worth taking a moment to outline what we see as Vital's key financial risks and what we're doing to mitigate these. Firstly, liquidity risk where you'll note my earlier comments on our strategy to introduce longer term debt to extend our weighted average maturity profile to not less than 4 years. Secondly, interest rate risk where we use interest rate derivatives to limit the impact of adverse movements in interest rates on our cost of finance. And thirdly, currency risk where our Australian operations are financed with Australian dollar-denominated debt facilities, thereby creating a natural currency hedge that we supplement by using foreign exchange contracts to limit the exposure of changes in exchange rates on the cash generated from these operations. I will now hand back to Aaron who will round out the presentation with Vital's outlook and priorities for FY '22.

Thanks, Michael. Slide 29 provides earnings and distribution guidance for FY '22. AFFO is expected to be at least $0.118 per unit or 2% above FY '21's record of $0.115 per unit. Distribution guidance of $0.095 per unit has also been issued. This is 5.6% above our last annualized guidance and 7% above FY '21. Distributions will remain around 80% of AFFO, with the balance of earnings retained to support future developments. Retained earnings also offset ForEx, which can be volatile, noting that Vital's functional currency is New Zealand dollars, but most of Vital's earnings are sourced in Australia and Australian currency. Healthcare property remains a defensive asset class, underpinned by growing demand and corporate activity. As Australasia's leading listed owner of healthcare property, we remain well positioned. Our short- to medium-term plan is to firstly continue to deploy Vital's 5-year portfolio strategy to continue to grow earnings for our unitholders. This is expected to include further asset recycling. Second, we will continue to focus on our current development pipeline, which has $136 million left to spend as well as our potential pipeline of circa $740 million. This will help us provide new and upgraded health facilities for communities across this region. Third, we will consider further acquisition opportunities across New Zealand and Australia to grow and enhance Vital's existing portfolio. Or we will look to further extend Vital's debt maturity profile and diversify sources of debt, building on work done in FY '21 to ensure security of returns for our unitholders. And finally, we will extend our sustainability program, including participating in GRESB and CDP to play our part in protecting and enhancing the environment, the communities in which we operate and the stakeholders we serve. Very happy to take questions.

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

Just first question just in relation to the debt duration extension, just to get sort of a bit of a feeling for where you're heading with that. So I mean that sits at 2.5 years with what you're sort of expecting to implement by in first half '22. Where do you sort of expect that average duration to sit at first half '22?

I'll hand over to Michael to respond.

Arie, so we're pretty confident that we'll be able to get that to that 4-year target that we're talking about at the moment. So we've got about $250 million worth of debt that is needs to be refinanced in the current -- in FY '22 and that's all achievable in that year.

Yes. And then just -- I mean, as you -- I mean, obviously, the balance sheet has got some capacity on it even after an eventful '21. Can you just sort of talk a little bit about how you're sort of thinking about acquisitions, in particular in FY '22? I mean, obviously, sort of on strategy to look for acquisitions, do you expect them to feature, and just a little bit about market conditions and whether you think it's too hot for assets at the moment?

Yes. So look, we are focused on acquisitions as well as other measures, but the best source of Vital's capital at the moment is developments. And you'll see that we do have a significant development pipeline. We acquired 5 assets that provide us significant growth opportunities there. So that's our first course of action. But to the extent we can acquire, we'll continue to do so where it makes sense for the overall portfolio and growing the return. So we're really focused on both. But you are right. I mean, cap rates have been hitting down and that makes it more challenging, but not impossible.

Yes. And just on that last point, I mean, just in terms of what some of the relationships you have in that, like should we expect to see sort of looking to focus on acquisitions where it's with existing partners?