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 FY '22. [Operator Instructions] I would now like to hand the conference over to Mr. Aaron Hockly, Fund Manager. Please go ahead.

[Foreign Language] Welcome to Vital's Interim Results Call. With me today is CFO, Michael Groth; as well as Richard Roos, Executive Director of Portfolio; and Chris Adams, Executive Director of Development. Other than some minor issues this morning, we are yet to have significant technology issues after 2 years of these remote calls from 4 different locations. But as always, our apologies, if any occur. Following acquisitions, developments, and revaluation gains recorded over the half year, Vital now holds a $3 billion portfolio of health care assets, 27% in New Zealand and 73% in Australia. Vital provides unitholders with exposure to high-quality assets across both countries and a significant exposure to Australian dollar-denominated assets and earnings. It is also important to reiterate in these times of elevated inflation that 86% of Vital's leases are linked to CPI in some way. Our core focus remains growing AFFO and distributions by 2% to 3% per unit per annum over the medium term, and we are very pleased with progress on this front over the half year. Vital's Board has today upgraded AFFO guidance to at least $11.9 per unit, up from $11.8 per unit previously. Distribution guidance has also been increased to $9.75 per unit on an annualized basis, up from $9.5 previously, with a payout ratio expected to remain around 80%. Upgraded guidance is expected to result in FY '22 AFFO being 3.2% above FY '21 and distributions 8.5% above FY '21. We have also continued to diversify Vital's portfolio by geography, subsector, and tenant. In light of the ongoing disruption from COVID-19, we wanted to highlight how we have continued to progress despite the pandemic. The strategies we have deployed and the metrics we are focused on have enabled us to continue to enhance Vital's quality portfolio built up over the last 22 years. In addition to increased diversity, we have maintained Vital's market-leading WALE at nearly 18 years and reduced the average building age. These metrics help us to ensure we can continue to deliver growth in earnings and distributions to unitholders. Vital's balance sheet has also been strengthened over the period, including a reduction in gearing to 33.2% and an increase in average debt duration. Michael will shortly provide more details on this, including our recent agreements to extend average debt maturity to over 4 years. Efforts over the last 6 months and beyond have enabled the upgrades to AFFO distribution guidance -- AFFO and distribution guidance announced today. Vital's balance sheet, including the current debt headroom of $291 million, leaves well positioned to fund Vital's existing and potential development pipeline as well as any potential acquisitions. Vital's Manager, NorthWest has continued to deliver for Vital's unitholders in accordance with our announced strategy, including sustainability, which I will come back to at the end of this presentation. Over the 10 years ended 31 December 2021, a period that largely aligns with NorthWest management, Vital has delivered a total return of 16.3% per annum, outperforming Vital's benchmarks. Works undertaken during the half year across the portfolio, developments, governance, sustainability, and capital management are expected to help us to continue to deliver for unitholders in future periods. Turning to the key highlights for the half year. Of the $161 million of new equity issued during the half, $142.8 million was raised primarily from existing investors via replacement at UPP. Proceeds were used to fund the acquisitions of The Tennyson Centre in Adelaide, which Richard will talk to shortly as well as to reduce balance sheet gearing to fund Vital's development pipeline. $314 million, approximately 10% of the portfolio by value was spent acquiring assets in Wellington, Adelaide, and post 31 December, 2 assets in Sydney. NTA increased by 8% per unit over the half year, primarily reflecting property revaluations due to a mixture of cap rate compression, rent increases, and development margins. As noted earlier, with a significant portion of Vital's income linked to CPI, property income is likely to increase with inflation. Around 80% of the leases linked to CPI, contain caps with the remaining 20% uncapped. CPI caps largely range between 2% and 5%, with a weighted average of just under 4%, where rent increases are capped -- leases typically also provide for periodic market reviews, providing an opportunity to capture earnings growth from market movements. Vital's net property income increased by 8.8% over the half year. This increase reflects contributions from acquisitions, developments and rent reviews, noting that these reviews are heavily weighted to the second half of the financial year and that actual increases lag CPI. It also reflects other adjustments such as disposals. Chris will shortly speak to Vital's 10 committed developments, which have $161.4 million remaining to be spent. This represents our committed developments and are below our target percentage of the portfolio under development. As a result, we are actively working on turning potential developments into committed ones. -- work done on this potential development pipeline, including land acquisitions, preliminary costings, planning advice, and discussions with current and potential tenants, coupled with our highly experienced team, give us comfort of being able to continue to deliver high-quality health care developments in accordance with Vital's strategy. I will now hand it over to Michael Groth.

Thank you, Aaron, and Good morning. We are pleased to be reporting another quality set of vital results for the half year ended 31 December '21. These results have been achieved despite the ongoing COVID-19 disruptions in New Zealand and Australia and are a testament to the strength and defensive qualities of vital in the property portfolio it owns. Starting at Slide 11. Vital's net property income is up 6.9% or 8.8% on a constant currency basis compared to the same period last year. Rental income growth, value-adding development activity, and continued capitalization rate compression have driven property valuation gains of $153 million. AFFO is up 14% or $3.9 million, equating to $5.91 per unit on Vital's increased issued capital back. A full reconciliation of operating earnings to AFFO is included in the appendices. Distributions per unit have increased by 8.6% for the half from $4.375 to $4.75 per unit. As Aaron outlined earlier, AFFO guidance has been upgraded to at least $11.9 per unit for the full year with second half distribution guidance also increased to $8.75 per unit, representing an annualized run rate of $9.75 per unit. This upgrade has been possible following the strong momentum in the business and in particular, the recent completion of Vital's merger with Eastern development, where rent commenced in February -- pricing benefits from the debt refinance and extensions announced today and the settlement of Hut Valley Health Hub earlier this month. This means we are well on track this year to achieve our strategic target of AFFO and DPU guidance and growth of 2.3% per unit per annum over the medium term. Delving into property income performance on Slide 12, income from the rentalization of developments, rent reviews and leasing activity on the existing portfolio have contributed $1.9 million to the overall $3.7 million increase. Property acquisitions both in the second half of last financial year and in the current period, net of disposals, have contributed a further $2.7 million. This growth has been partially offset by the stronger New Zealand dollar versus the Australian dollar on the income from our Australian properties. On a like-for-like basis, net property income increased 1.9% and off the back of structured rent reviews and leasing activity, noting that approximately a quarter of the portfolio income was subject to rent reviews during the period that will deliver annualized rental growth of 3.7%. Reviews on the remaining portfolio will occur in and underpin income growth in the second half of the year, noting that in aggregate, some 86% of rent reviews are indexed to CPI with some subject to caps. Turning to Slide 13 and Vital's balance sheet. Our active capital management raised $143 million of new equity for the half, reducing debt to gross assets by 1.8 percentage points to 33.2%. Vital's distribution reinvestment plan also remained active, raising over $12 million, and is on track to raise over $24 million for the full year. These initiatives, together with earnings that are retained by Vital's conservative distribution payout ratio and asset recycling initiatives like the sale of healthy care assets in FY '21 and Gold Coast Surgery Centre in the current period are important and flexible sources of funding for Vital's committed development pipeline. The investment property portfolio grew by over $300 million or 11.6% following acquisitions and revaluations, and I'll speak more on this shortly. Reflecting the above Vital's net assets increased 8% or $0.23 per unit to $3.12 as compared to 30 June. Turning to Slide 14. Independent valuations were received over approximately 77% of the portfolio by number, leading to $153 million of property revaluation gains. These gains have been driven by capitalization rate compression accounting for about $100 million with the year balance attributable to rent increases, leasing activity, and development profits. Cap rates across the portfolio have tightened 21 basis points over the half to 4.67%. On Slide 15, net tangible assets have increased $0.23 from $2.89 to $3.12 per unit, reflecting the impact of the revaluation gains net of deferred tax highlighted earlier. Turning to Slide 16. We have continued to develop and deliver on reshaping our capital structure by prioritizing the diversification of our funding sources and extending the debt maturity profile. Subsequent to balance that, we are pleased to report that further progress has been made with terms agreed to refinance all near-term debt expiries, meaning the next expiry is not until October 2023. Increased facility limits by AUD 150 million, including securing Vital's third tranche of 7-year debt, extending the weighted average debt facility duration to 4.4 years, and further improving Vital's all-in weighted average cost of debt. Following these changes, Vital will have access to AUD 291 million of undrawn debt headroom to meet development and acquisition commitments and opportunities. Turning to Slide 17. Vital's capital position remains strong with the October equity raise and debt facility increased secured post balance date, maintaining or improving all key metrics. As you will know from our debt maturity profile included on this slide, Vital has been successful in securing AUD 250 million of long-duration debt across 3 tranches and from 2 banks. This 7-year debt delivers on strategy and increases alignment between our long-duration property cash flows and the certainty of term and cash flows of the debt that in part finances these properties. These capital structure actions completed ensure that we have more than sufficient limits and capacity in conjunction with potential capital recycling initiatives to support Vital's growth opportunities, including its committed development pipeline. I will now pass you to Richard, who will take you through the portfolio and recent acquisitions.

Thank you, Michael, and Good morning from Melbourne. Before reviewing the strategy behind 4 recent Vital acquisitions, let me first provide an update on several portfolio-related items. While Chris will touch on the additional resources his team has added to deliver on the development pipeline, Northwest also continues to invest in new staff to manage the growth of the portfolio with the asset management team recently adding additional property and asset management resources in Melbourne and Auckland. In addition, we have created a new role for a senior leasing executive, who will focus on development-related leasing. It is worth noting that due to a combination of growth with new operator partners and a sale by health care of its surgical business to new owners Vital has substantially reduced its tenant concentration risk from 50% of income from its largest tenant to 20%. As Aaron detailed, despite the challenges generated by COVID, Vital had strong CY '21 net property income of $113 million and strong positive rent growth during HY '22. Post year-end, Australia experienced a significant surge in Omicron cases. Fortunately, this wave of positive cases and hospitalizations has fallen dramatically since the initial surge in early January. And by the end of February, all restrictions on elective surgeries will have been lifted. The financial impact on Vital and its key operator partners of the latest shutdowns have been limited. All Australian hospital operators have continued to be provided with significant financial support from the state and Commonwealth governments. As a result, rent relief has been minimal and over 99.5% of rent has been collected for January and February. In the medium term, private hospital operators in both Australia and New Zealand will benefit from increased demand as governments in both countries work to reduce long waiting lists for elective surgeries. In Australia, for example, before the most recent shutdowns in surgeries, data showed the number of patients waiting for surgery for more than a year had nearly tripled to 57,000. Turning to the acquisition slides, starting with the Hutt Valley Health Hub in Wellington. This newly constructed ambulatory care facility, which we settled on earlier this month, is located in a medical precinct anchored by the Hutt Public Hospital and Vital owned Boulcott Private Hospital. The acquisition provides Vital with a direct relationship with the local DHB as well as a large local GP group who together account for over 60% of the rent roll. The weighted average lease term by income is over 14 years. The acquisition also includes land for future expansion, which combined with the land previously held by Vital, exceeds 3,200 square meters and creates an opportunity to master plan the precinct with our tenant partners, including Boulcott Hospital. The next slide provides details on the acquisition of The Tennyson Center in Adelaide, South Australia. Tennyson, which is located 3 kilometers southwest of the Adelaide CBD is Adelaide's leading cancer center of excellence, comprising market-leading tenants in the identification, assessment, and treatment of cancer through oncology, radiotherapy, imaging, surgical, and consulting services. It provides Vital with new or expanded relationships with a number of key national medical providers in GenesisCare, Icon, and Nexus Day Hospitals, which has already led to additional leasing and acquisition opportunities for Vital. It was identified in due diligence that a substantial number of the leases expired around the same time and that Icon was a crucial tenant as it held the direct relationships with the key oncologists. As a result, prior to removing due diligence, we successfully negotiated a 10-year extension to the Icon lease, which also substantially increases the renewal probability of the other tenants. The large landholding of over 14,500 square meters includes a development parcel of nearly 2,000 square meters. Turning to Slide 22, This slide highlights the acquisition of the development land adjacent to The Hills Clinic in Northwest Sydney. With a focus on adolescent mental health, The Hills Clinic is owned by Vital and operated by Aurora, one of health -- one of Australia's largest providers of mental health services. This is a highly strategic acquisition to facilitate future expansion of the hospital, one of the strongest performing assets in the Vital portfolio. The transaction is being done in partnership with Aurora, who have provided an underwrite and 100% precommitment to the planned development, which will provide at least 60 additional beds to the existing 85 beds. The lease term for the new development will be coterminous with the existing lease at circa 25 years. Slide 23 provides details of a multistage development site in a high-growth area of Southwest Sydney and Vital has contracted to acquire on an 85-year ground lease. Stage 1 of the development will be leased for a minimum of 15 years to Genesis Care, the largest provider of integrated cancer care in Australia who will operate a cancer care center of excellence. The first stage is targeted for completion in late 2023 with an expected value of AUD 52 million. The acquisition also includes an additional 23,000 square meters of land, of which 10,000 square meters is proposed to be developed for a day surgery and mental health facility. Management are in ongoing discussions with one of Australia's largest hospital operators who have expressed strong interest in partnering with Vital and leasing the proposed facility. The balance of the site will be held for future health care, education, and research-related uses. Settlement of this opportunity is expected in March. All of these acquisitions highlight our strategy of acquiring or developing best-in-class assets with a focus on medical precinct locations. Our strategy isn't about growth for growth sake. It's about strengthening asset quality, diversifying and expanding our tenant relationships and creating value-add opportunities that enhance yield. We also regularly review our portfolio to ensure our existing assets are on strategy. As Michael mentioned, our most recent review resulted in the disposal of the Gold Coast Surgical Center, an asset with chronic vacancy after the closure of an adjacent public hospital. This asset was sold for AUD 13 million or 5% above book value. I will now turn the presentation over to Chris, who will provide an update on our development book.

Thank you, Richard, and good morning all. As is well known to vital investors, the development strategy is a key component of the Vital business and one that continues to mean that we are well placed to enhance the earnings and capital upside to the overall portfolio, improve asset quality that meets the demands of modern health care delivery, meet the needs of our operating partners and importantly, deliver improved sustainability outcomes to our partners and the community more broadly. In order to achieve these aims, NorthWest has invested heavily in our development capability. And we have a team now in excess of 10 people that has unmatched experience across the sector in Australia and New Zealand. This also means a highly researched approach to development opportunities that focus on our key precinct and inventory care strategies. On the basis of this analysis, Vital is well placed for future development opportunities in growth corridors in Southeast Queensland, Sydney, and New Zealand on strategic sites owned by the fund. Currently, committed projects totaled circa $300 million, of which half of this spend remains. The broader development book sits at approximately $1 billion over the medium to longer-term, which will be activated over time following detailed master planning, due diligence, including business cases and governance processes. Next slide, please. Key highlights in the half-year include further opportunity to work with key partners, Evolution Healthcare and Southern Cross to expand and upgrade a number of existing facilities. The Epworth Eastern project in Box Hill, Melbourne, reaching PC for clinical floors 1 to 10, with completion of the balance of the 14-level tower expected this coming Monday. Completion of the first stage of Playford Health Hub in Adelaide to activate this key precinct, with commencement of Stage 2 pending and ongoing progress with leading not-for-profit health care group, Calvary Health Care for Stage 3 and completion of the first stage of the complete rebuild of Wakefield Hospital, enabling Stage 2 being the rebuild of clinical areas to commence. Slide 27 provides the breakdown of the $304 million committed work in progress. These projects have been delivered at an overall net development yield of 5.5%, well ahead of the weighted average cap rate for the Vital portfolio. Importantly, these projects remain on track despite the impacts of COVID on the construction industry. The development team has worked proactively with key contractors to minimize disruption to sites in the last 2-year period and are very focused on construction cost escalation and procurement challenges when considering new projects. Playford Health Hub in Adelaide on Slide 28. As noted earlier, demonstrates a key health precinct opportunity for Vital investors and one in which the integrated development, leasing and asset management team are making significant progress. The investment is expected to be circa $170 million by Vital with key operators also to make material levels of investment. Stage 1 to activate the site, including the 250 car base leased directly to SA Health and a retail offering to provide precinct amenity is now complete. Stage 2 commencement is due for mid-2022. In facilitating the opportunity, the team continues to work collaboratively with a range of precinct stakeholders, including Playford Council, NALHN, the public health provider, SA Health, key Adelaide universities, and Calgary Healthcare. These key stakeholders have formed a precinct Advisory Board for the Northern Adelaide Health Precinct, which includes Adelaide's third-largest public hospital, Lyell McEwin, and the Playford Health Hub. The establishment of the Precinct Advisory Board provides a unique opportunity to bring together several organizations with the ability to drive change, grow the precinct and improve health outcomes for the community. The parties have also collectively funded a precinct director to facilitate the ambitions of the overall precinct while taking up the learnings from other major health precincts as it grows. With a focus on sustainability, the Playford Specialist Medical Center enables us to have an exemplar project that prioritizes categories, including energy, indoor environmental quality, and building materials. Targeting a 6-star, Green Star rating and a Well Health and Safety rating, the building will be all-electric, have 30% lower embodied carbon and 100% of the base building energy will be sourced from renewable power sources. Through improved building efficiencies and delivery of additional amenities such as end-of-trip facilities, the building seeks to positively contribute to the environment and enhance the user experience. Slide 29 provides the details of the brownfield development funding approved for key Evolution and Southern Cross hospitals, including expanded scope for Wakefield Stage 2 and investment in the growth occurring at Grace Hospital in Tauranga. These projects are all supported by strong business cases that demonstrate the demand for core services driven by high-quality hospitals and associated population dynamics where these facilities are also increasingly part of the provision to help relieve the pressure on the overall public health system in New Zealand. I will now hand it back to Aaron.

Thanks, Chris. Slide 31 provides our sustainability targets for this financial year following the release of Vital's first sustainability report last August and Northwest first sustainability report last December. As Richard and Chris have noted, NorthWest have been hiring across all of its Australasian offices over the last 12 months. This has enabled us to increase the diversity of our workforce across a range of measures and allowed the appointment and promotion of additional women into several key roles. Group-wide NorthWest has enhanced its professional development program with an emphasis on diversity and mental health. We are also well advanced in developing a baseline environmental reporting for energy, water, and waste, and this will assist with external reporting as well as encouraging better usage of resources going forward. Our 3 key financial sustainability targets have all been met or exceeded with AFFO and distribution guidance for the first half year met. Our payout ratio kept prudent at around 80% and debt extended and diversified. We continued our charitable and community support programs in Australia and New Zealand, including pledging to fund the 3-year scholarship with the Keystone Trust in New Zealand. Vital's specific sustainability builds on Northwest wider program. I note, in particular, Northwest's recent commitment of $5 million to fund research and to COVID-19's impact on health care systems around the world. Vital is the owner of a significant portfolio of assets. So ultimately, it is through Vital's properties where we can make the biggest impact. Vital participated in the Carbon Disclosure Project or CDP in 2021, recording a significant uplift in results from the prior year. This uplift is the result of general sustainability initiatives we have introduced our ESG partnerships with key tenants, notably Epworth HealthCare and our specific focus on increasing solar power across Vital's Australian portfolio. Vital joined the Green Building Council of Australia in 2021 and will look to join the Green Building Council of New Zealand later this year. In addition to CDP, Vital has committed to participate in the Global Real Estate Sustainability Benchmark, or GRESB, this year. These international benchmarks are not ins in themselves, but means to inspire a meaningful change throughout our organization and beyond. Finally, turning to outlook and guidance. As noted earlier, we have today upgraded FY '22 AFFO and distribution guidance whilst also retaining a prudent payout ratio. As we have brought several developments to completion over the last few months, Vital's committed developments now have $160 million left to spend. As a result, we will look to turn the potential pipeline into committed projects over the balance of FY '22 and beyond. As Michael mentioned, several mechanisms are available to fund these developments as well as any potential acquisitions, including approximately 20% retained earnings per annum, asset sales, and future valuation growth. Another funding source is the DRP, which has around a 50% participation rate, raising approximately $24 million per annum. We remain cognizant of the importance of sustainability, both in terms of Vital's longevity as an entity and in term of solid vital and Northwest impacts on the communities in which we operate. As always, full details of Vital's governance arrangements, strategy and portfolio are available on our website, vhpt.co.nz, where you will also find our contact details. We will now take questions.

[Operator Instructions] We will pause a moment for any questions to register. Thank you. There are no questions at this time. I'll now hand back to your speakers for closing remarks.

Thanks, everybody, for your attendance today, and apologies for some technical issues we had at the start of the call, delaying the start and also some during the call. Have a good day, and we're available for questions via e-mail or via the website. Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.