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

Thank you for standing by, and welcome to the Vital Healthcare Property Trust FY '26 Half Year Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Chris Adams, Chief Executive Officer. Please go ahead.

Thanks, and welcome to the interim results webcast for Vital Healthcare Property Trust for FY '26. My name is Chris Adams, and I am the CEO of Vital, and I am joined today by Vital's CFO, Michael Groth. Our result is entitled Position for the Future, a function of the recent internalization of Vital and the overall positioning of the portfolio, whereby significant work overtime has us well set. Before we move on to the half year, it is worthwhile reminding ourselves of the fundamentals which drive the Vital business, the tailwinds in terms of health sector fundamentals. Approximately 17% of New Zealand and Australia's population is aged 65 plus. This age group is forecast to grow to more than 20% within the next 15 years and on average, spends 3x to 4x more on health care services. Total health care spending represents circa 10% of GDP for each of New Zealand and Australia and is forecast to grow by up to 4% per annum, driven by an aging population, new technologies and treatment. The private sector will continue to be the beneficiary of increased demand with approximately 2/3 of elective surgeries performed from the private sector as the public sector cannot meet demand for services. And a significant deficit exists in the public health infrastructure, particularly in New Zealand as evidenced by the recent release of the Infrastructure Commission's infrastructure plan, which highlighted the pressing need for investment in health. Vital is well-positioned to support the public and private sector meet this via our specialist platform and expertise. The highlights for the half year '26 at a portfolio level reflect operator performance returning to the industry benchmark of 50% rent to EBITDA or 2x rent cover across the Vital portfolio, driven by ongoing strength in New Zealand and continued improvement in Australia. $98 million of asset sales reinvested in high-quality developments, 4% like-for-like rental growth, ongoing recognition by GRESB as a global sector leader for ESG for listed health care property for the third year running. Along with leasing success continuing to drive occupancy to 99% at end December and dividends forecast at $0.0975 per unit for the full year. Turning to Page 6 for the overall highlight for the period being the internalization of management, something we believe will be strongly value-accretive over time and now aligns Vital with its peers in New Zealand. Vital has retained a full-service Trans-Tasman team of sector specialists and a key task for the calendar year is to separate back-of-house services, including HR and IT from the Northwest platform. This structure also provides full alignment with investors, management and the Board and will ensure the full benefits of acquisitions, development or capital partnering over time flow fully to unitholders. I will now hand over to Michael for details of the financial results and capital management.

Thank you, Chris, and good morning. Adjusted funds from operations, or AFFO, for the half, $0.0564 per unit, up 13.7% versus half year '25. Distributions paid per unit are steady at $0.04875, meaning Vital's AFFO payout ratio for the half is 86.4%. Our annual distribution guidance of $0.0975 per unit is unchanged. Unpacking these results further. Net property income is up 4.7% over the prior comparative period, driven by like-for-like constant currency growth of 4%. Corporate expenses were down to $2.3 million as a cost control focus was maintained. Net interest expense was up $1.4 million to $24.5 million as a result of higher average debt balances and a reduced interest capitalization, which was partially offset by lower interest rates and a stronger average Australian dollar for the period at $0.8899 versus $0.9092 provided a tailwind for the conversion of Vital's Australian dollar-denominated earnings. As Chris spoke to earlier, Vital has now completed the internalization of management. This is a transformational transaction for Vital that is expected to be 1% to 2% accretive to AFFO future earnings and more generally accretive to unitholder value over time. With the settlement of this transaction occurring on the 31st of December, there are several impacts recorded in this half and more broadly anticipated prospectively that I wanted to draw your attention to now. In the current period and as expected, the internalization payment has been expensed to Vital's operating profit and is classified as a strategic transaction cost. A tax deduction against the New Zealand income has been applied with Vital's residual tax expense reflective of forfeited Australian holding tax credit and the weighted average number of units on issue increased significantly because of the November equity raise in advance of unlocking the internalization benefits. Looking ahead, from the 1st of January '26, Vital's management fees will be replaced with the operating costs of Vital's internalized management platform. For the current half, $12.6 million in management fees were incurred, of which $11.2 million was expensed through operating profit. On Slide 9, we highlight the net property income is up $3.5 million or 4.7% over the prior comparative period. On a same property, constant currency basis, Vital reported a strong 4% increase in net property income. The improved occupancy has contributed almost $0.5 million to net property income with the balance being reflected as increases in CPI and other rent reviews and portfolio mix changes. Importantly, the market reviews completed in the period delivered a 1.4% increase, underpinning the sustainability of rents of our properties and reinforcing the continued improvements to hospital operator performance that Chris highlighted earlier. Vital's balance sheet remains solid with gearing down 2.4 percentage points to 39.7%. Vital's property portfolio increased to $3.4 billion and valuation capitalization rates stabilized during the period. Approximately, 36% of income-producing properties were independently valued. The portfolio weighted average capitalization rate of 5.49% was marginally tighter than 30 June in both New Zealand and Australia. Net tangible assets per unit were $2.34 at 31 December, down from $2.47 at 30 June as property valuation gains and currency translation benefits from a stronger Australian dollar were offset by the impact of the internalization transaction. On Slide 11, you will see that Vital has maintained strong capital and funding metrics with leverage below 40% at 39.7%. Material headroom versus banking covenants exists. Debt duration remains solid at greater than 3 years. There are no debt expiries until March '26 and prudent facility limits remain available. Turning to Slide 12. Vital has actively managed interest rate risk with $375 million of incremental cover added in the current half, focused on increasing protection in later years. At 31 December, Vital is 85% hedged at a rate of 3.52% with a weighted average hedge duration of 2.6 years. I will now pass you back to Chris, who will talk about the Vital portfolio.

Thank you, Michael. Slide 14 demonstrates the level of diversification across the business. In terms of geographic diversification, with a focus on key cities across the Eastern Seaboard of Australia and population centers in New Zealand, and by hospital operators working with leading operators in both countries. In addition, almost all leases having a CPI fixed or market review across the full year. On Slide 15, we outlined the status of market reviews, whereby we are approximately 1/3 of the way through the market reviews for the full year with an overall increase of 1.4% noted by Michael and no falls in rent. The balance of market reviews are against well-performing hospitals with upside above this level expected. We also have enjoyed ongoing leasing success to be 99% occupied at end December. This is in line with the long-term trend in the business at circa 99%. The key period of variance to this being periods of ramp-up of certain development projects over time. This level of occupancy is also supported by a WALE of 19 years, again, up period-on-period as leases have been renewed or extended due to active asset management or as part of lease extension due to brownfield development. In relation to developments on Slide 17. Vital has continued its long-dated strategy to support the growth of operating partners, enhance the quality of the portfolio and returns over time with a core focus on medical precincts, which are proven to deliver higher growth with lower risk. In the half year, 3 projects reached practical completion along with RDX post balance date with completion of this building earlier this month. The recent strategy has been to be shovel-ready in the broader development book to enable activation of projects once market conditions and circumstances around particular projects warrant commencement. We are pleased today to announce that Kawarau Stage 1 in Queensland has been approved for construction, and I will detail this further shortly. The committed development pipeline stood at $257.9 million at 31 December, with $63.7 million left to spend. When the recently approved Kawarau project is removed from these numbers, the spend on the balance is modest, with RDX having reached PC as noted earlier, Wakefield Level 5 operational with rent being paid and Grace set for completion by midyear. In respect of RDX and the Gold Coast Health and Knowledge Precinct, we have now reached practical completion as noted earlier. This 6-star Green Star design building enjoys a premium location and sets a benchmark for the precinct. The key factor in delivering to the expectations of the business case is future leasing success with the asset subject to a $3.7 million rent guarantee for 12 months post practical completion. Leases and nonbinding heads of agreement to date approximate 50% of the building area. This represents Vital's first major life science project with assets of this nature well documented as having leasing success from PC. We know very active inquiry -- excuse me. And anticipate an 18-month ramp-up with the impact of AFFO subject to leasing outcomes. In announcing the Kawarau Stage 1 project today, we note the key considerations to commencement being the strategic location opposite Queensland Health 600-bed Kawarau Hospital, a project whereby early works have commenced and despite a delay with the main works, the project was recently upscaled following review by the new state government. Is subject to binding pre-commitments for 35% of net lettable area or 37% by forecast income, with broader tenant interest expected to be strong is being activated in a timely manner given early works have previously been committed with a forecast completion of mid-2027 and is being delivered by a highly reputable contractor under the standard form Vital Design and Construct Contract. And delivers a forecast net yield of 6.5% with upside rent reversion over time, a likely feature of the Queensland market due to population growth and supply constraints driven by Olympics and other infrastructure projects. And now turning to the outlook for the business. Guidance remains at $0.0975 per unit, but on an improved payout ratio. Sector tailwinds and a quality portfolio mean we believe we are well positioned for the future. The Board and management are pleased with the successful internalization of the business, but it remains for us to fully integrate the back of house and to be highly disciplined as we seek to drive AFFO and dividend growth over time. In the short-term, this will be influenced by the success of development projects, including at Kawarau, leasing success at RDX and balance sheet discipline. Thank you, and we will now take questions.

[Operator Instructions] Your first question comes from Nicholas Hill from Craigs Investment Partners.

You mentioned the 4% growth in like-for-like net property income. Just for my own clarification, would it be possible to go through the components of this 4% figure? Rent reviews and leasing activity seem to result in an underlying growth rate in the high 3s. Was the remainder due to the decrease in vacancy?

Nick, it's Michael Groth here. That's correct. So, the underlying vacancy improvement was $0.5 million. The rest is coming through from CPI and structured rent reviews in that portfolio.

Okay. And with hospital operator rent to EBITDA now sitting at 50%, do you expect this figure to now stabilize and start trending downwards? Or do you still see some scope for any near-term decreases, which I guess would largely be driven by the Australian portfolio?

Nick, it's Chris. Yes, exactly as you just outlined, I mean, we're still seeing quarter-on-quarter improvement in Australia, and we expect that to continue. The fundamentals are there to drive that improvement. The health funds are being somewhat more cooperative with the operators, plus discipline at a cost level, also volumes continue to trend in the right direction. So very much an Australian story in terms of continued improvement. New Zealand is continuing to travel. The direction of travel there is continued positive outcomes from the businesses.

And then one last one for me before any else have a go. On the Kawarau Health Precinct Stage 1, that 37% pre-committed figure, does that include the Stage 1 extension part we can see in the illustration?

No, it doesn't. I mean we haven't committed to that. We believe that's an obvious proposition to extend if we have the level of demand to support that as we build the first stage. The likes of Queensland Health will not pre-commit to a building. They will only take space in buildings that are in construction. There's a significant element of demand in that catchment. And there's a whole range of other service provision, including cancer services where there's demand in that catchment. So, there may be an opportunity to continue to expand that building, and we'll put permits in place to do so, but the numbers presented are now only the first stage.

Your next question comes from Arie Dekker from Jarden.

Just firstly, I just want to just check my understanding of a few things in relation to the tax benefits on internalization. So, I think there was -- IRD was reviewing a component of that. Has the final tax benefit, and I see what you've recognized in the balance sheet. Is that all finalized as at balance date?

Arie, it's Michael here. No. So our tax binding ruling request went in before Christmas. The IRD has guided us to a mid-March response. So, at the moment, the numbers that we've reflected there reflect the tax advice that we obtained from KPMG and ASX, around the tax deductibility of that internalization payment. But those numbers are obviously subject to the final IRD ruling.

And then just looking for a bit more clarification in the period on the approach because -- and there's a few things going on in tax, but the tax number landed lower than I had. Did you take tax benefit in New Zealand tax through in the first half? And if so, how much?

Yes, is the short answer, Arie. So, because the internalization payment was made on the 31st of December, we're entitled to a tax deduction on that amount. The IRD ruling that we were talking about a moment ago, really only in everything that we understand at the moment is really only around the quantum. It's not necessarily a question as to its tax deductibility given the precedent. In terms of how that's flowed through the numbers for the half year result, so the residual tax expense that you're seeing in Vital's financial results represents the Australian withholding tax that becomes forfeited because there's no New Zealand income to claim those credits against. So that -- that's the position at 31 December. That's a higher number because we've sold certain capital assets in Australia during the period than what an underlying run rate is.

And then in terms of the go-forward and approach in AFFO, and assuming that binding ruling is received, then is the approach going to be through the period that the tax benefit is wound down that essentially there won't be any NZ tax impost through AFFO until it's wound down and the tax will relate only to the tax you pay with regards to the Australian earnings?

That's correct, Arie. Yes.

I guess, just -- you didn't cover it off in an earlier part of the question, but what was the quantum of tax benefit in New Zealand realized in the first half.

So roughly $6 million.

Roughly $6 million.

Correct.

That's great. Just one of the points that came up in the internalization and recognize that that's only just been put to bed. But just looking forward through this calendar year, is there any intention sort of through this calendar year to progress any discussions with Northwest on potential divestment of an asset or assets in return for cancellation of the shares?

No, there's no current discussions of that nature, Arie.

And just then looking forward, like any intention this year to progress discussions on the -- as far as the BHP entity is concerned?

I mean, as a business, we'd be open to an approach if it was in the best interest of unitholders. But certainly, there's no discussions on foot in that regard. So, we're open-minded. It would be my view to continued options to work with Northwest at a variety of levels. And obviously, they remain a very major shareholder in the business. But it fundamentally has to be the right answer for the broader unitholder base of Vital.

No, that makes sense. And then just one quick one on Kawarau. Just what's your sort of current assessment? Because obviously, you've got a chunk pre-leased in that and you've got sort of, I guess, now 15-odd months through to completion. What sort of is your target for what you think sort of achievable in terms of leasing commitment on completion for this one?

I think if we look at a reference point in a recent project, place is the best example. We started with a slightly lower level of precommitment. This is very much a bread-and-butter type asset for us in terms of what we do and do well. I can't off the top of my head tell you the PC number, but 12 months from PC, it was 97% by income. So, we would expect strong numbers out of Kawarau in that PC through 12 months post. There's definitely strong demand in that corridor, evidenced by the fact that the state government is spending over $2 billion on a 600-bed hospital. They're also -- and dialogue -- and we dialogue with them directly, they're not even confident that's going to cope with the level of services in terms of outpatient other services they need to provide in that catchment. It's a little time away as well, 31 to completion. So that's a real opportunity for us to land certain of those services within our assets. So yes. Does that answer the question?

No, that's a helpful reference point. And then just the last one, just on the reval -- it's not a big reval, but just sort of -- just some comment just on the reval versus the cap rate, Australia versus New Zealand, just the revals were sort of split 50-50, but the cap rates, I think, were down 1% and 7% sort of respectively. 1 and 7 basis points, sorry.

Yes. So, the Australian -- I suppose focusing on the Australian movement in particular, there was one material asset as part of the portfolio that had an independent valuation that is driving that. Broadly speaking, the rest of the assets, capitalization rates were effectively fairly constant over the last 6 months.

And the view is that they'll remain relatively constant. There's a bit of noise around interest rates. But ultimately, we see rent growth as the driver for valuation upside over time.

[Operator Instructions] Your next question comes from Rohan Koreman-Smit from Forsyth Barr.

Just following up on Arie's question around the tax and the fact that you'll wind down the benefit with low or no tax paid in New Zealand. Does that mean you'll have a structurally lower payout ratio for a period? Just given when the internalization was done, you always sell it on a net basis after the tax benefits. That's how it was kind of committed or communicated to the market. Just wanting to see if actually that tax is being distributed?

That's correct, Rohan. So, you'll note that we talked about the payout ratio sitting at 86% for the half. That is down from what we were reporting at 30 June, which had a 92%, 93% payout ratio. So yes, that's ultimately what is flowing through the numbers and how we're thinking about, I suppose, payout ratios and distributions at this point in time. If the underlying business continues to perform, then there's obviously certainly opportunity to revisit that in due course.

And then just your comments around balance sheet. See exactly where that is. Just focus on the balance sheet. It's obviously something investors point to given you run higher gearing than peers. Has there been a change in mindset since internalization around appropriate gearing ranges and also maybe the tail of assets that you hold? Is there more potential to recycle capital now than say, 3 months ago?

I don't think our strategy and our thinking around balance sheet and capital management has changed, Rohan. So, the defensive cash flows, the continuing performance and improving in performance of our key tenants, et cetera, mean that we're pretty comfortable where leverage is from a group perspective. Recycling capital is always on the table for the right opportunities and the right transaction, if it adds value to unitholders, then it's very much something that we will pursue. We've pursued it historically. I can't see that scenario changing.

And then just thinking about the comments on operator performance and your own market rent reviews. Obviously, there's been nervousness around Healthscope and what could come out of those. You're probably further away from that or those discussions than you were previously. But can you give us some color on, I guess, how those are progressing? I see there's a bunch of kind of proposals that have been knocked back. But is there any kind of color you can give on the likely outcome or outcomes of that?

Yes. I mean the color is and most of this has been communicated through the press. And so, I think we'll stick to that information. But there's clearly -- well, we've sold some core assets and some very strong assets, the likes of Gold Coast and National Capital, and there was strong demand for those assets. So, Ramsay and Marda respectively successful on those hospitals. But there was other large-scale groups at or around that price point. So, there's clearly demand for good assets. What it leaves is really the 2 portfolios along with Prince and Randwick a couple of them balance sheet assets and then the property portfolios. It's public information that Northwest has a deal on foot with Calvary, but the -- and HCW have made it public that they have other counterparties to take up to leases which we obviously don't know the detail of. But the company is elected or at least the finances are elected to go for the for-purpose entity. That shows that they believe they have a sustainable business. So now there's really a bit of a battle between the parties whether the for-purpose entity goes forward or the alternative scenario of Calvary and other operators. So, I mean, we'd like to see resolution of that. I'm sure the participants in the market would like to see resolution of it, but it is getting closer and there's clearly demand, and the underlying dynamics of the sector continue to improve, and that's part of the -- I suppose, the situation that the parties can recognize that it is an improving market.

And importantly, though, and as we've highlighted in the information that we've provided today, Vital's portfolio in terms of rental affordability from our perspective is in very good shape, 1.4% rent review or market reviews on those that have come up and that position is something that we think we should be able to exceed on the residual balance of market reviews for the remainder of the year.

So yes, and that provides a relevant distinction between the Vital portfolio and the likes of Healthscope because from what we do know, they're certainly not at that -- whilst they're improving, they're certainly not at those sort of levels of operating performance.

And sorry, one last question. Just my understanding previously was you have quite a few rent reviews weighted to the second half. Is that true with kind of the period coming up, just given Aussie inflation and I guess, New Zealand inflation remains relatively sticky?

That's right, Rohan. So, we've got some material market reviews coming up on some of the larger hospitals in our portfolio and there's the structured rent reviews, which are very much whilst broadly speaking, balanced 50-50 between half 1 and half 2. There is a lot coming through. The second half ones are weighted towards the final quarter.

There are no further questions at this time. I'll now hand back to Mr. Adams for closing remarks.

Thank you for your time today. And if any further questions come to light, please do not hesitate to reach out to Michael or myself. Thank you very much.

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