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

Thank you for standing by, and welcome to the Vital Healthcare Property Trust HY '23 Interim Results Presentation. [Operator Instructions] I would now like to hand the conference over to Mr. Aaron Hockly, Fund Manager.

Welcome to Vital's 2023 Interim Results Call. Before we begin, I would like to acknowledge the recent natural disasters in New Zealand. Although there has been minimal damage to Vital's properties, our thoughts are with those impacted, including several of our tenants and the families of our staff. Vital and Northwest have donated to the Red Cross to support emergency relief. These results highlight how we have continued to deliver on our core business strategies for our unitholders. The benefit of Vital's defensive sector and the managers' defensive strategy become more obvious in times like these have heightened economic uncertainty and rapidly changing market conditions. Vital continues to have an enviable and unmatched portfolio of assets, anchored by a 78% exposure to many of the leading private hospitals across Australia and New Zealand. This high quality portfolio and the stability of our tenants' underlying earnings enabled us to record a 3.7% like-for-like increase in net property income over the half. We continue to enhance the portfolio, particularly through developments in core healthcare precincts. Sustainability remains a priority for us. And so we will also continue to increase Vital's exposure to green buildings. Notably, Vital has one major development underway targeting at least 5-Star Green Star and 2 major developments underway targeting 6-Star Green Star, including RDX, which Chris Adams, Executive Director of Development, will speak to further. Over recent months, we have taken steps to extend Vital's debt facilities through over 4 years, extend weighted average interest rate swaps to cover 67% of drawn debt on a weighted average term of 2.9 years and increased debt headroom to $250 million, providing capacity to fund Vital's development pipeline. CFO, Michael Groth, will provide more details of Vital's finance facilities and strategy shortly. Late last year, we commenced the program to sell at least $200 million of noncore assets with the proceeds to be reinvested into new developments. Richard Roos, Executive Director of Portfolio, will provide more details of this program. Our core goal of growing AFFO and distributions by 2% to 3% per unit per annum over the medium term remains unchanged and distributions for the half were 2.6% above the prior corresponding period. We also reaffirmed our commitment to the highest standards of corporate governance. As noted in Vital's 2022 Annual Report, we have complied with all relevant principles of the NZX Corporate Governance Code, notwithstanding that the code does not technically apply to Vital as a fund issuer. We also reaffirmed our other sustainability commitments. Pleasingly, efforts by the team on this front were rewarded during the half through Vital being ranked 2nd place globally for listed healthcare real estate by international benchmarker, GRESB. At 31 December, 2022, Vital owned a $3.5 billion portfolio of 47 income-producing healthcare assets, $2.5 billion of which is spread across all mainland states of Australia and $1 billion in New Zealand. Consistent with Vital's statement of investment objectives, we continue to focus on a range of key portfolio metrics, including those shown on this Slide 5. Activity over several periods has reduced single tenant exposure to 18%, reduced average building age to a young 11.1 years and significantly increased net property income. The delivery of strategy has also resulted in 220% growth in NTA over the last 10 years, distributions for the half are 27% higher per unit than 10 years prior, ongoing capital management, including regular capital raisings at modest discounts and ongoing extensions and expansions of debt have been critical to the returns we've been able to deliver. Notably, upon execution of credit approved terms which we have received, Vital will have no debt expiring until March 2025. Sustainability results received during the half year include Vital's 5-Star rating from GRESB, the highest rating available. As noted, Vital has 3 major developments underway at a cost of over $250 million, which are targeting at least 5-Star Green Star. This represents approximately 50% of Vital's committed development pipeline by value and all of Vital's current developments include environmentally sustainable design aspects. Our development program, targeted asset upgrades and divestments will result in a significant improvement in the sustainability credentials of Vital's portfolio over coming years. Turning to some additional highlights from the half year. In addition to debt tenure and headroom extension, balance sheet gearing sits at a conservative 33.7%. $156 million of acquisitions were undertaken during the half to enhance the portfolio and support future earnings growth. Our focus has now shifted from acquisitions, majority funded through equity raisings to developments partly funded through asset sales. Vital's underlying earnings increased by 20.3% over the 2022 calendar year. During the half, rent reviews averaging 3.4% were completed, which will support growth in earnings in future periods. As Richard will touch on shortly, our future rental growth is expected to be higher than previous periods, reflecting a higher inflation environments due to the majority of Vital's leases being linked to CPI. During the half, $86 million was spent on capital works, the bulk of which was on expansion and development work. Over the 3 years ended 31 December, 2022, $370 million or approximately 11% of the portfolio's value was spent on capital works, mainly the development and expansion of buildings. This has helped keep Vital's portfolio modern and fit for purpose. Vital currently has 12 developments underway with $369 million remaining to be spent, including RDX, which was committed to during the half. Full details of all current developments are included in the appendices. I will now hand over to CFO, Michael Groth.

Thank you, Aaron, and good morning. The last 6 months, we've seen a rapid and aggressive response by the world's central banks defining inflation with New Zealand and Australian cash rates increasing by 1.35% and 2.5% respectively. Against this backdrop, Vital continues to prioritize prudent capital management, ensuring that the foundations of the business remains strong. In the last 6 months, we have actioned $200 million in capital recycling initiatives, that Richard will discuss in more detail shortly, the proceeds of which will be reinvested to upgrade the quality and the resilience of our property portfolio and expand our presence in healthcare precincts; Increased interest rate risk protection by over $300 million to about $785 million, most of which is in place until at least June 2025; and agreed terms to increase debt facility limits by $107 million and refinanced near-term expiries such that our next maturity will not be until March 2025. This materially strengthens Vital's financial position. Turning to Slide 12 and the results for the half. Vital's net property income is up 24.4% compared to the prior corresponding period or 20.3% on a constant currency basis. This [ $14.1 million ] increase is attributable to rent reviews, property acquisitions settled over the last 12 months and the completion of a number of developments, including the circa $100 million expansion of Epworth Eastern around this time last year. Management fees have also increased in line with the growth in the property value. As you all have expected, interest expense net of interest income and interest capitalized has increased substantially, up by almost 27%, reflecting the approximate 300 basis point increase in Australian base rates to 3.12% at 31 December. I'm calling out the increase in Australian base rates because the vast majority of our borrowings are denominated in Australian dollars, providing a partial natural hedge against the circa 70% of assets and associated income that are located in Australia. Unrealized or non-cash property revaluation losses of $54 million have been booked in the half, following a modest softening of capitalization rates, particularly in New Zealand, partially offset by the impact of rent reviews on valuations. Adjusted funds from operations per unit reduced 2.5% to $0.0576, still delivering a prudent 85% payout ratio on distributions of $0.04875 per unit declared for the half. The drivers of growth in net property income are presented further on Slide 13. Of note is the 3.7% per annum like-for-like property income growth on a constant currency basis. Richard talks further about Vital's rent review profile and both its linkages to CPI and the timing of rent reviews later in this presentation. On Slide 14, we present Vital's balance sheet. Gearing has increased modestly from 30% to 33.7% following the settlement of contracted acquisitions, development CapEx and the property valuation loss discussed earlier. NTA is $3.17 per unit, which although down $0.17 for the half is still up from $3.12 12 months ago. At this point, I would like to make a couple of comments on the capital management initiatives we have implemented to ensure Vital's balance sheet remains strong and resilient. We've undertaken a detailed review of Vital's developments. We have prudent opportunities like the Tasman Medical Centre have been deferred while the business case is interrogated further. A $200 million asset recycling program has been initiated with the first asset to be sold currently under exclusive due diligence and the marketing campaigns have commenced for the other properties. Sale proceeds will be reinvested into developing new high quality assets that are completely aligned to our portfolio strategy. Interest rate hedging has been increased to 67% on a pro forma 31 December basis to provide increased certainty on Vital's cash flows over the short to medium term. And importantly, near-term debt expiries and funding requirements have been addressed with terms agreed for $107 million in increased facility limits. The further diversification of our finance partners that will result in the next facility maturity not being until March 2025. All of this means we are currently forecasting that our committed development pipeline, including the recently announced RDX transaction, will be fully funded, while maintaining gearing on completion below 40% after allowing for further modest softening of property valuations. Slide 15 highlights how Vital's property portfolio has been funded in some of the key metrics at 31 December. On a pro forma basis, that is after the documentation and financial close of the credit approved terms that have been accepted by Vital, undrawn facility limits will be about $250 million. The weighted average debt duration will increase to 4.2 years. And there will be no facility maturity until March 2025. Bank lending covenants are well within limits with LVR sitting at 35.5% versus a limit of 55% and ICR at 3.2x versus a limit of 2x. Turning to Slide 16, you'll see the details on how we are managing Vital interest rate. As I indicated earlier, we've been active over the last 6 months to increase the certainty of cash flows, and therefore, unitholder distributions. Over $300 million in additional hedging protection has been secured through a combination of new hedges and the restructuring of existing hedges. At 31 December, on a pro forma basis, the hedging book has a weighted average duration of 2.9 years, a weighted average fixed rate of 2.91% and covers approximately 67% of drawn debt. This level of interest rate protection is likely to increase over the short-term as the proceeds from asset sales are initially implied to paying down debt facilities. I'll now pass you to Richard, who will take you through the portfolio and the areas of focus in the short to medium term.

Thank you, Michael, and good morning, everyone. First of all, like Aaron, I would like to express our concern for the residents of coastal communities on the Far North and East Coast of the North Island impacted by Cyclone Gabrielle. While Vital's assets have been unaffected by the recent weather events, our thoughts are with those who have not been so fortunate. Turning to Slide 18. The message on the next 2 slides is that Vital has a stable low-risk portfolio, one that is diversified by tenant and by location with income growth that is strongly aligned to CPI. With an occupancy of 98.4% and a 17.2 year weighted average lease term, Vital's portfolio provides income stability with a per annum average lease expiry over the next 10 years of approximately 2%. Of the 2.5% of the portfolio leases that expire in 2023, 80% have been renewed and the rest are in negotiations. In 2024, approximately 4% of the leases expired, 1/3 of which relates to an asset that is held for sale. Due to the specialized nature of [indiscernible] and location and a medical facility or precinct, Vital's medical tenants are highly likely to renew their leases when they do expire. Geographically, 70% of the portfolio of our income is located in Australia with 30% in New Zealand. The Australian portfolio with a value of $2.5 billion consists of 17 hospitals leased to 4 different operators, 6 ambulatory care assets and 8 aged care facilities with a collective WALE of 16.6 years. The $1 million invested in New Zealand assets consists of 9 hospitals with 6 different operators and 7 ambulatory care assets on a WALE of 18.5 years. Vital has a diverse tenant mix with market-leading operators. By way of example, Aurora Healthcare is Vital's largest tenant at 18% of total rent. Aurora has a portfolio of 16 private hospitals, 8 of which are owned by Vital, with over 1,000 mental health beds, 500 rehabilitation medical beds and a range of outpatient and day programs, making it one of the largest private providers in Australia's mental health and rehabilitation sectors. Our largest New Zealand tenant is Evolution Healthcare at 11% of total rents. Evolution Healthcare is one of New Zealand's leading providers of private hospital services that operates 3 hospitals, Wakefield and Bowen Hospitals in Wellington and Royston Hospital in Hastings, along with investment holdings in Grace Hospital in Tauranga and Endoscopy Auckland. Vital is a property partner across all 5 of these assets, including Grace Hospital operated in partnership with Southern Cross. Turning to Slide 19. As mentioned by both Aaron and Michael, Vital's portfolio is strongly aligned to CPI with approximately 81% of Vital's rent linked in various ways to CPI. With the spike in CPI still a recent phenomenon, it is only now being factored into annual rent reviews. This is because the rent increase for the next 12 months of rent is calculated over the last 12 months of CPI. As a result, Vital expects to see increased like-for-like rent growth for the balance of FY '23 and beyond. Another consideration is that unlike many goods and services, demand for most medical services is not a discretionary expense. In times of increasing costs, people may cut back on restaurant meals or wait to buy a car, but choosing to delay a surgery or medical treatment is not usually an option. As a result, Vital's tenants will continue to see strong demand for their services in spite of the current economic challenges. On Slide 20, again, as highlighted by Aaron and Michael, we provide additional details of our current asset recycling strategy with a target to divest circa $200 million of assets by 30 September. The 2-fold strategy, which is already well advanced, is about recycling noncore assets to efficiently fund our development pipeline and the upgrading of Vital's portfolio by replacing older, less energy efficient assets with modern, high quality, sustainable buildings with a lower carbon footprint. We have commenced a formal sales campaign on over $300 million of assets. And we look forward to updating you on our progress over the coming months. I will now hand over the presentation to Chris Adams, Executive Director, Development, who will update you on our development book.

Thank you, Richard, and good morning all. Slide 22. As noted by my colleagues, the long-standing development strategy for Vital remains a key feature of the business, although a greater degree of caution exists regarding the addition of future opportunities. Importantly, execution of the development book remains on plan across the delivery of 12 projects under construction. The key drivers of these projects remain; working with key operating partners and delivering to their portfolio improvement and growth agendas and our desire to continue to high grade the Vital portfolio, and in particular, a focus on green buildings and the sustainability of our overall portfolio and to deliver to our overall prudent strategy. In executing on both aims, we have selected regarding the properties that are pursued with a view to right projects at the right time. A key part of the strategy is to ensure we are shovel-ready across our development book to capitalize on market opportunities as they arise. Slide 23 details the work in progress noted earlier. With $369 million left to spend, of which $180 million of this is in the coming 12 months. The weighted average yield at 5.6% reflects a 70 basis point spread to forecast upon completion yields. We see yields on future projects trending higher as higher cost of capital and increased rents driven by the impact of underlying inflation impact project returns. Slide 24 highlights 2 key projects at mental health facilities at Abbotsford in Perth and Belmont in Brisbane, with practical completion having been reached at Belmont and the main construction works completed at Abbotsford with licensing and refurbishment of the older part of the hospital to follow in the near-term. These projects represent ongoing support for Aurora, as noted by Richard, a market-leading operator in the mental health subsector. Slide 25 highlights Vital's most recent development and commitment at [ Parkland ] on the Gold Coast, named RDX, Research and Development Centre of Excellence, $140 million project, including lands with a net book area of approximately 12,000 square meters. This project is part of first life sciences development and is positioned in the Lumina Precinct, a key health and innovation precinct curated by Economic Development, Queensland, Griffith University and Queensland Health. Importantly, this project has all of the key attributes of precinct advantage sought by Northwest as part of the precinct strategy of Vital, including co-location with Gold Coast University Hospital, the Healthscope operated Gold Coast Private Hospital and Griffith University, a major university which serve 20,000 students. It is designated and will be built to a 6-Star Green Star certification, the only building with this level of sustainability credentials in the health market in Queensland. The facility will have life science uses, but is also flexible and is designed to accommodate hospitals and other clinical services. The development yield expected from RDX at 5.6% compares favorably to a number of very recent health and life science transactions in key precincts at yields of 4% to 4.75%. And it's being delivered by Icon Construction, a Tier 1 builder with an extensive relationship with Vital, including having recently completed the Epworth Eastern project in Melbourne. I will now hand back to Aaron to outline the future focus for Vital.

Thanks, Chris, and turning to Slide 27. FY '23 distribution guidance remains $0.0975 per unit. This is 1.2% above FY '22 and will provide a 2.2% compound annual growth rate for the 5 years ending 30 June, 2023. The payout ratio for the half was a conservative 85%. We note that underlying earnings growth at a property level has largely offset the negative impacts of higher debt costs and a high New Zealand dollar versus the Australian. Our core strategies are well known to investors and have not changed. However, we are adjusting to market conditions through increasing interest rate hedging and debt headroom as well as moderating our acquisitions and developments and expediting our portfolio strategy through the sale of noncore assets. Key to our asset management and development success are the relationships our team has built up over 2 decades as well as the pure healthcare focus of the Northwest Group. We're now happy to take questions.

[Operator Instructions] Your first phone question comes from Nick Mar from Macquarie.

Could you just talk through -- I still haven't gone through in detail, but the valuations. I see it was flat Aussie and sort of down quite a decent amount in New Zealand. What have you sort of revalued there? And you talked through some sort of cap rate business and what's been factor?

So we've had independently valued at about 50% of the portfolio by value. So we've tended to focus on a mixture of Australian and New Zealand assets and tried to separate them across geographies, so you get a sense of what's happening across different assets. You've seen in the report that we've released details of the specific assets that have been independently valued versus those that are directors' valuation. Was there a second part to the question?

Yes. So that 57% decline, what sort of value was that on for New Zealand? Is it like a 10% down number or given any portions being valued?

Nick, this is Richard. We did have a slightly larger movement in cap rates in New Zealand, which is expected given the more spends of movements in interest rates in New Zealand. I don't have the exact numbers in front of me, but I think...

About a 5% decline in the New Zealand portfolio.

And less than that in Australia.

So is that 5% for all the valuations against whole portfolio value or just 5% from the independent valuations against those that were valued independently?

So Nick, it's Michael here. So the way that we go through our valuation process is while we get independent valuations over about 50% of the portfolio on a rolling basis, that's used to directors' valuations as well. So it's representative of the value of the whole portfolio. The 5% decline is in relation to the New Zealand portfolio. The Australian portfolio with the rent reviews that have come through, was about flat for the period.

And then just on asset sales, is the sort of the number of listings come up, so sort of Apollo and Napier in New Zealand and then Lingard, Sportsmed and Southport in Aussie. Are you sort of expecting only a portion of those to actually sort of find acceptable price levels in terms of what you're targeting in the next kind of 6 months or are you expecting some of them to be sort of longer-dated settlements as those processes conclude? And secondly, just with the New Zealand asset, was there any impact on Napier from the recent cyclone?

Nick, it's Richard again. So first of all, with respect to Napier, I mean, out of respect for what's been -- what's happened in the community, we have paused our sales program on Napier until we can -- until that community is back on its feet. With respect to the balance of divestments, we're currently marketing approximately $330 million worth of assets in New Zealand dollars. As you pointed out, the 2 assets in New Zealand are Napier and Apollo, the balance of the assets clearly being in Australia. We expect to see pretty strong demand, particularly in Australia for the Australian assets. And there's a number of funds that are keen to acquire additional healthcare assets and are well capitalized. So we expect strong demand. And our strategy is that we will accept the best offers that come through on approximately $200 million worth of assets. And we're targeting a settlement of that $200 million pre-30 September.

Your next question comes from Shane Solly from Harbour Asset.

Apologies, I have not had a chance to go through the numbers either to the degree I'd like. Can you just talk to us about the interest rate used in guidance? What are you putting in the forecast?

So it's Michael here. The -- look, we go to the same sources as what you do. So we look at what the yield curve is panning out to be for the remainder of this year and obviously future years. That informs what we forecast for.

So if I sort of go through sort of BBSW in Australia 3.5%?

So 3-month BBSW in Australia is about 3.5% at the moment. So the 1-year scope is probably the other extreme is much less than 4%.

And what about currency?

Sorry, Shane. I was just going to say that that's part of the reason why we haven't given AFFO guidance for this financial year because of significant swings in interest rates. We do have distribution guidance sitting there. And we expect that that gives us a little bit of room to move whilst keeping that payout ratio around about 90% or below.

Aaron, that helps because it was going to be my next question. So well anticipated. In terms of FX in the guidance, what are you assuming there?

So a look through at the moment on FX is around that $0.91 mark.

[Operator Instructions] Your next question comes from Rohan, Forsyth Barr.

Just one quick one for me. You've got your $200 million target by September end what looks to be $350 million plus of assets potentially for sale. How willing are you to sell the whole lot or is $200 million kind of where you want to stop?

We'd be happy to sell the whole lot if we got offers that we thought were in the best interest of unitholders. So $211 is really seen as the minimum, but we're happy to look at how we fund future growth basically.

And just inquiry levels on those assets and the one you've got held for sale, kind of how is the process panning out so far versus expectations when you started this a few months ago?

Rohan, it's Richard here. We're very encouraged by the demand for healthcare assets. Again, in particular in Australia, we've got a significant number of smaller REITs and other groups that are focused on acquiring noncare assets. So we expect very strong competition between those periods through these assets. And while they're noncore for Vital, they're going to be received very favorably in the market in our opinion. So early indications are that we've got a very strong interest.

There are no further questions at this time. I'll now hand back to Mr. Hockly.

Thanks everyone for your time today. All of our details are available on our website and happy for people to contact us direct via the website as well. Thank you.

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