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

Thank you for standing by, and welcome to the Vital Healthcare Property Trust FY '25 Full Year Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Chris Adams, Co-Head, ANZ Region. Please go ahead.

Thank you. Good morning, and welcome to the Financial Year '25 Annual Results Webcast of Vital Healthcare Property Trust. My name is Chris Adams, and I am the Co-Head of North West in the ANZ region and lead the Vital business. I am joined by my fellow Co-Head, Richard Roos; and CFO, Michael Groth. Vital continues its long-standing strategy of investing in high-quality health care real estate across New Zealand and Australia. The core focus for the period has been a proactive approach to the portfolio in a period of continued market uncertainty. We have seen improved metrics in terms of overall occupancy and portfolio WALE, the highest in the market, the completion of additional developments as the existing development pipeline reaches a conclusion. Improved debt terms as a material refinance was concluded in the year, which demonstrates the strong support of the business from our banking group, with this support representative of the strength of the underlying assets and their associated cash flow. Overall, Vital has continued to enhance its portfolio by development, sale of noncore assets and investment in core medical precincts. When market conditions permit, we will again look to activate the embedded value of the Vital portfolio via its development pipeline. On Slide 4, we set out the case for health care real estate and our high conviction remains for the [indiscernible] components of the health care real estate spectrum in which Vital operates. In particular, there is no doubt of the increasing future need for health services to support a growing and aging population in New Zealand and Australia. Further supported by emerging technology, increasing consumer expectations, including a need for consumer-centric care and a preference for either medical precincts or alternatively low-cost centers of care, such as ambulatory care. Slide 5 defines other factors driving investment in Vital, which include quality of the portfolio, the duration and quality of cash flows, highly experienced management and health care property and robust governance by our majority independent Board, improving performance of our operator partners and Vital also currently offers investors in New Zealand a gross dividend yield of 7.3% and a unit price trading at a 19% discount to NTA. In calling out the highlights for FY '25, the strong operational focus delivered positive leasing outcomes with occupancy now at 98.6%, and this upward trend is expected to continue as we lease the balance of vacancies, predominantly made up of high-quality recently completed development space, like-for-like income growth of 3.7%, enhancement in overall finance arrangements for the trust, which Michael will talk to shortly. Continued positive outcomes from our ESG focus, including again being recognized by GRESB, as sector leader in health care development globally. Successful development outcomes and ongoing rationalization of lesser assets, enabling a stronger business. Recognition of projects at Ormiston and Macarthur with key industry awards, demonstrating the quality of these projects and payment distributions of $0.0975 per guidance. I will now hand over to Richard to provide further insight at a portfolio level.

Thank you, Chris, and good morning, everyone. In FY '25, we continue to focus on our core strategy of building a more resilient portfolio, which includes the focus on portfolio fundamentals. That focus has resulted in Vital leasing, renewing or extending lease term on 51,000 square meters of lettable space, which included 9,400 square meters of new leasing. The combined extensions and new leases represent 22% of Vital's total annual income, 20% by portfolio area and with no material lease expiries for the next 18 months. With an extended WALE of 18.5 years, our leasing focus has significantly enhanced Vital's income security. A commitment to sustainability is another way we are building a resilient portfolio. By way of example, we have implemented climate resilience audits across the entire Vital portfolio to ensure our assets are protected from climate change. These audits identify works that are required to ensure building operating performance and higher temperatures or protect against flooding from increased rainfall in addition to identifying other climate-related risks. We're also performing regular night audits to ensure we are appropriately matching energy demand with energy usage, which reduces cost to tenants and our carbon footprint. Focus on investment in these areas will protect the long-term value of Vital's assets, while also ensuring strong interest from debt and equity providers. We are proud of the recognition and awards that Vital has received for its commitment to sustainability. Our commitment to sustainability extends to our developments for the same reasons as our existing assets. Both the GenesisCare Cancer Center in Sydney and Playford Health Hub in Adelaide achieved 6 Star Green Star certification in FY '25. As a result, these developments are delivering better energy and water performance with lower operating costs, less embodied carbon usage and a lower carbon footprint post development completion. We're also committed to obtaining similar outcomes for both the RDX and Endoscopy Auckland developments. I will now hand the presentation to Michael, who will take you through the financial results.

Thank you, Richard, and good morning. Turning to Vital's financial results and capital management outcomes for FY '25. Operating profit before tax increased 4.8% from $73.9 million to $77.4 million. This result reflects the strong underlying performance of operating business and was driven by a 3% increase in net property income and lower management fees. Distributions of $0.0975 per unit were paid to unitholders for the year, consistent with the prior period and our guidance, representing an adjusted funds from operations or AFFO payout ratio of 93.6%. AFFO per unit was [ $0.1041 ], down from [ $0.1090 ] in FY '24, impacted by higher tax expense due to the previously flagged building depreciation charges of New Zealand, [ thin ] capitalization in Australia and higher interest expense versus income growth from recently completed developments. Corporate expenses were tightly controlled, increasing marginally by 1% to $5.9 million. Management fees were down substantially by 28.5% to $17.7 million, reflecting both lower asset values and no manager incentive fee for FY '25. As briefly mentioned a moment ago, net interest costs increased to $45.2 million or by 11.2% as developments completed and transition to income-producing properties, thereby ceasing interest capitalization. Rounding out final results before tax was an unrealized property valuation reduction including a write-down of the RDX development and mark-to-market adjustments on interest rate swaps totaling $125.2 million in aggregate. The waterfall on Slide 13 sets out contributors to Vital's 3% increase in net property income versus FY '24. I wanted to draw your attention to the 3.7% on a constant currency basis, increase in like-for-like net property income. This strong underlying growth reflects both that 82.5% of rent reviews are linked to CPI, including capped CPI multiplies for some, and a dedicated focus on enhancing portfolio occupancy, particularly from recently completed developments, and longer term vacancies. As Richard will talk to in a moment, further enhancing operational performance has been a priority for FY '25, resulting in occupancy lifting to 98.6% at June. In the second half, occupancy lifted from 97.7%, with this leasing momentum continuing into FY '26. Vital's capital position and balance sheet remain strong. Gearing was 42.1%, up 3 percentage points from FY '24. Vital's transparent and long-dated cash flows from tenants whose businesses deliver in-demand nondiscretionary services, underwrite both the quantum and the servicing cost of this leverage [indiscernible]. On the investment property front, Vital's weighted average capitalization rate softened by 23 basis points to 5.54% at June. The improving real estate sector sentiment generally and health care specifically has led to emerging signs that property values are stabilizing. In New Zealand, the weighted average capitalization rate for the second half tightened by 4 basis points to 5.63%, while Vital's Australian portfolio softened by 14 basis points to 5.49%. Reflecting the above, net tangible assets per unit were $2.47, down from $2.69 at 30 June last year. Continued proactive and disciplined capital management delivered great results for Vital in FY '25, culminating in the refinance and term extension of $1.1 million of debt facilities announced in May. This refinance delivered a weighted average debt maturity improvement to 3.8 years, with no maturity before March 2027, enhanced pricing and removal of an LVR pricing grid, and increased multicurrency facility flexibility. This result was possible following the strong appetite and engagement from our existing banking partners and is a pleasing endorsement of Vital's high-quality, defensive, diversified long-dated cash flows and property portfolio. I note that Vital's interest cover and bank LVR at 3x and 43.6%, respectively, were well within [indiscernible] banking covenants. On Slide 16, enhancements to the interest rate risk protection continued throughout FY '25 with interest rate hedging increasing to 82% with a weighted average duration of 3.2 years. Hedging efforts have and will continue to focus on proactively adding duration to Vital's hedging book. I will now hand you back to Richard to take you through Vital's asset management outcomes for the...

Thank you, Michael. Turning to the property and sector update. As we have raised on previous calls, private hospital operators, particularly in Australia, saw margin compression post-COVID due to accelerated cost pressures, particularly with wages, combined with high fixed overheads and slow recoveries of surgical volumes. As a consequence, our operator partners have spent the last 3 years focusing on becoming more efficient, reducing use of expensive agency staff, prioritizing higher-margin activities through case mix management and maximizing the use of existing assets rather than consider expensive new greenfield developments. Combined with the significant increases from insurers, this focus on efficiency has resulted in a substantial improvement in financial performance, as demonstrated by the current rent-to-EBITDAR ratio of 51% for the Vital portfolio, which sits just outside the benchmark range of 40% to 50%. This is good news for our operating partners and Vital. With New Zealand operators continuing to trade strongly, it provides an opportunity for them to invest in partnership with Vital in additional capacity to support the public system. High-quality assets like those in the Vital portfolio will continue to perform strongly. With the high cost of development, replacement costs for the Vital portfolio exceed the current book value, providing our operators with a competitive advantage and making it difficult for new entrants. It will also drive accretive brownfield development opportunities over the medium-term. Vital has the highest quality investable health care portfolio in both Australia and New Zealand. With over 82.5% of rent increases in FY '25 aligned to CPI, Vital's $3.2 billion portfolio generated income growth of 3.7% on a like-for-like and constant currency basis. Its portfolio and income stream are highly diversified by location, tenant and health care use. Since 2013, Vital has reduced its reliance on its single largest tenant from 40% of income to less than 19% today, with overall occupancy strong at 98.6%. We expect that occupancy number to continue to increase over the first half of FY '26 as we finalize leases for the remaining vacancies, including in our recently completed developments at Playford and Ormiston. Vital's tenants include many of the largest health care operators across Australia and New Zealand with roughly 2/3 invested in the larger Australian health care market and 1/3 invested in New Zealand. These top-tier operator relationships are critical in that they provide Vital investors with a diversity of income across different operators, geographies and hospital types, strong covenants that provide security of income and significant opportunities to grow income, and enhance assets through expansion of existing hospitals. We also confirm that the Vital portfolio has no exposure to Healthscope, which is undergoing a restructure and likely sale of the operating businesses by the receiver due to aggressive levels of debt, which were utilized by private equity when the portfolio was acquired in 2018. As mentioned previously, during FY '25 through active asset management, Vital leased, renewed or extended lease term on 51,000 square meters of lettable space with no material lease expiries for the next 18 months. This result is reflective of the high quality of the portfolio. In addition, Vital's WALE has increased from 18.3 years at the end of FY '24 to 18.5 years at the end of FY '25, notwithstanding the passage of a year. Our strategy of providing in-house development, leasing and asset management capability to support the renewal and expansion of our existing assets, a selective divestment of bottom quartile assets, combined with our focus on medical precincts, has resulted in our tenants making longer term commitments to our hospitals and ambulatory care centers. I will now turn the presentation back to Chris to provide an update on development.

Thank you, Richard. In relation to development within the portfolio, we have seen a material spend within the portfolio across FY '25 of circa $109 million. This sees the existing development pipeline in runoff with only $36.9 million of spend to complete committed projects, whilst acknowledging the successful development of 530 million of projects completed in the last 5 years, again, demonstrating the improved quality of the overall portfolio with these projects expected to deliver long-term value upside. On Page 23, the Wakefield expansion is well known to investors. The new clinical areas of the hospital have been operational from January of this year. The success of the project is evidenced by the need for early activation of the Level 5 expansion space to provide an additional 34 beds to support the demand for [ better ] services. We are very proud of this project in conjunction with Evolution Healthcare, which positions Wakefield as the premier private hospital in Wellington. The $16 million expansion of Maitland Private Hospital in the Hunter Valley of New South Wales was completed in September 2024, including additional space for mental health services and medical oncology, along with improved hospital amenity. Page 25. In relation to committed developments, updates are as follows. Boulcott reached practical completion on 30 July and is now operational following a complex build and a live operating environment, with the expansion officially opened by Ministers Brown and Bishop only last week. Auckland Endoscopy is well advanced for an expected September completion. Wakefield Level 5 is expected to complete late this year, and GRESB is on track for mid-2026. The exception in program terms is RDX, which is now programmed to conclude in early 2026, some 6 months later than anticipated due to the impacts of Cyclone Alfred and challenges with the complex atrium works, which span 8 levels. The impact of this delay is neutral to Vital, with liquidated damages payable by the contractor, offsetting additional finance costs. In respect of leasing, these projects are all 100% pre-committed, with the exception of RDX, whereby a 12-month net operating income guarantee exists for 57% of budgeted net income based on our expectations of the business case. And at this time, agreements for lease and [indiscernible] agreement are not yet at this level. In concluding redevelopments, it is important to acknowledge these projects support the demand for new service, as experienced by our operator partners, and continue our strategic focus on medical precincts. Turning now to the outlook for Vital. We continue our proactive approach to optimization of the portfolio. We forecast distribution guidance of $0.0975 across FY '26, consistent with FY '25. Over the medium-term, we see resilience with the business, particularly as sector demand dynamics again support the overall business and recent challenges in the health care sector in Australia abate. We consider ways to activate embedded portfolio value and return to AFFO and distribution growth, all with a perspective to credible ESG initiatives. Thank you, and we will now take questions.

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

First question, just on payout expectations for '26. You paid out 93.5% of AFFO for '25 from just under 90% in '24. Are you expecting the payout ratio is going to increase slightly in '26 also?

No, Arie, it's Michael here. So we expect the payout ratio to be slightly less than that from '26.

Great. Okay. Just one asset held for sale, I think, and sort of not much in the way of mention of the divestment program, which has been sort of more prominent in the last sort of 18 months. I understand there's an asset you're looking to sell part of in the South Island. Can you just comment on what the intentions are on divestment at the moment and the extent of what is being actively marketed?

Yes. I think in sort of recent discussions, we've seen that more as business as usual process. It's about actively curating the portfolio. So yes, from time to time, there are absolutely assets in the process. There is an asset in the South Island, which -- there is a process which is ongoing. That asset is more of a capital partnering type initiative where we're looking to partner with a group that can add value in commercial components and we can in the health components. But that's just part of the broader ongoing business as usual proposition that we see in the portfolio going forward. As those types of transactions become committed, obviously, we'll notify the market accordingly.

But yes, like I said, I mean, you have talked previously about you put a value on assets that you're looking to divest. There's nothing beyond those 2 assets at the moment and you're sort of winding down the divestment activity. Is that what you're sort of indicating?

Yes. I think we're saying it's business as usual. We've been proactive about the business, about what we sort of [indiscernible] in the portfolio, about upgrading the overall business, and we'll continue to do that where we see value in that equation. So yes, I think it's moved from a proactive divestment program to a business as usual program. That doesn't mean we won't sell [indiscernible].

Okay. And then last one, just on RDX. I mean, just perhaps without referencing the underwrite, can you just sort of give some detail on where you're up, where you're at with, I guess, these heads of agreements and what sort of space it kind of covers and then sort of what your expectations are on lease-up, say, over the first 12 months at least post completion?

Yes. Thanks, Arie. It's Richard. First of all, we're quite confident in the medium-term leasing for that asset. It is a very, very high-quality asset in a growing medical precinct on the Gold Coast in Queensland. Our only competition in the precinct, which was completed about 8 months ago, is now over 80% leased. There are no plans for any other development currently to kick off in the precinct. So we will become the only opportunity and the highest quality opportunity in that precinct. Suffice to say that we're currently still below our 57% rent guarantee. We do expect that -- at completion, which is, as Chris indicated, likely be in February, we do expect that we will be drawing on that guarantee for some period of time. We've got very good momentum over the last couple of months with interest and a couple of new heads of agreements. And I would guide to -- like our play for development in Adelaide. I would guide to what would be considered a virtually fully occupied building with sort of 18 months to 2 years from PC.

And I'd probably add to that, [ I ] said that life science buildings, which that is -- by their very nature they tend to lease up at the end of the proposition when the building is absolutely available to tenants. And it's not typical -- a lot of these businesses are start-up businesses or businesses that have matured from start-up. They have a degree of venture capital funding or government funding, et cetera. So you're actively working proactively with a range of stakeholders, including the tenants, to make these things happen. So there's a lot of work behind the scenes going on. And there's a lot of support in various levels of -- to make RDX success.

Yes. That's some helpful context. And then just on, I guess, those agreements that you have entered into, what amount of the space does that sort of cover at the moment?

At the moment, Arie, I think we're in the sort of the 35% to 40% range in terms of committed heads of agreement, unconditional AFLs and we've memorandums of understanding.

Your next question comes from Nick Mar from Macquarie.

Just further on the sort of asset recycling piece. Capital partnering was something you talked about a while ago, and there's obviously something small going on in the background. But are there any sort of broader and larger discussions underway at the moment in terms of releasing some capital and bringing some third-party money in to help accelerate those development opportunities?

Yes. I mean, it's part of the toolkit. We are still considering it. We're probably considering it on a more nuanced and refined basis in specific assets and development type opportunities. The context in Australia around Healthscope, and we do see resolution of the Healthscope issues been obviously going on for some time, but I think we're in the final sort of -- straight of final processes to drive resolution there. I think that will provide clarity for the broader market, and we will still look to capital, [ but ] much like -- I think the comments are just very similar to the comments we made earlier regarding divestments. It's part of the toolkit. We see as an opportunity, but we don't have anything to report at this time. And as and when we do, obviously we'll communicate, but it's certainly part of the toolkit that we see for the business going forward.

Okay. That's helpful. And then just in terms of Healthscope, do you think that resets at all the sort of cost to serve in certain catchments if the new operator and then also possibly [ not-for-profit ] operator can crystallize a sort of lower capital base for the hospitals and therefore, sort of offer services possibly more attractively? I was just trying to work out whether that has an impact on the overall sector's profitability or requirements of profitability and therefore, impacts the sort of potential to pay rent?

Thanks, Nick. It's Richard here. We're obviously very close to that scenario given the investment by Northwest in one of our other funds, in a joint venture. We have 12 hospitals in that joint venture with [ Ascot ]. And so we're very close to the situation, and we're very committed to ensuring that we retain reasonable rents, that we provide certain incentives. But overall, we would expect that the rent EBITDARs and the rent costs for those facilities would be very similar to what the rent is paid by the balance of our tenants. The real issue, as I indicated in my remarks, is around $1.6 billion of debt that was put in place in 2018 by private equity.

I think adding to that, though, it has been a catalyst to government in Australia to really push the health funds. The health funds did very well during the COVID period, not surprisingly because they weren't making [ payouts ]. And that -- and obviously, the cost pressure within operators. The outcome of the Healthscope situation is that we have seen the health funds being more proactive in recent times, very material increases to operators and a recognition and part of that -- voluntarily and part of that being pushed by government and others. So, I think we're seeing a more sustainable proposition going forward. I think that's more about the normalization of things rather than resetting a cost base to a lower level. And the rents at that 50% type number Vital, at 51%. That's not where Healthscope is at. And then -- and there's various components of Healthscope as well. So -- and there's some very good assets and very strongly performing assets in there. So, maybe that provides you a bit more clarity.

Your next question comes from Rohan Koreman-Smit from Forsyth Barr.

Questions just on the kind of earnings in '26. If you take the second half and annualize it up, you kind of end up with AFFO of maybe around $73 million, $74 million. There's obviously lower interest costs, hopefully, as we cycle down the debt curve, fixed rental increases, no -- probably no management incentive fees paid and lower base fees as well given lower asset values. I guess the question is, what is the risk to '26? Is it just that RDX you don't get the leasing up, and that's one of the reasons for the caution in the near term, and that's probably a key thing holding back dividend growth for this year with kind of those other factors helping to lift things again in '27?

It's Michael here. I mean the short answer is yes. That's correct. So, I suppose we want to ensure that we're prudent in looking at, I suppose, future aspects, future forecast effectively for the group. So that's certainly at the back of our mind. While we think the risk is dissipating just from a general sector perspective, we are conscious that RDX is an important development that is due to complete throughout FY '26. And while we're confident around leasing, we know with these types of assets and our existing assets that leasing up does take time that it needs to, to get full occupancy on those buildings.