Waypoint REIT (WPR) Earnings Call Transcript & Summary

Hello, and welcome to the Waypoint REIT Half Year '23 Results Webcast Call. [Operator Instructions] I will now turn the conference over to Hadyn Stephens, Managing Director and CEO. Please go ahead.

Thank you, operator, and welcome to everyone joining us on the call this morning. Starting on Page 7 of the presentation, I'll quickly call out some of the highlights for the 6 months to 30 June. Distributable EPS for the half of $0.0828 was in line with the guidance provided at the start of the year, but down 3.7% on the corresponding period with key drivers being lower rental income as a result of asset sales and higher interest expense, partially offset by rental growth and a lower number of securities on issue as a result of the buyback program last year. In relation to valuations, we saw a further 12 basis points of cap rate expansion during the half, with Waypoint REIT's overall weighted average cap rate now having increased by 39 basis points over the last 12 months to 5.4%. Cap rate expansion during the half was partially offset by contracted rent increases on 360 properties incorporated in the June valuation process with an overall investment property valuation decline since December of $27.2 million or 0.9%. Despite this valuation decline, Waypoint's balance sheet remains strong with gearing at the lower end of our target 30% to 40% range, no debt expiries until 2025 and further hedging put in place in the first half, resulting in 93% of our current debt book being hedged for the 18 months through to the end of 2024. Turning to leasing. Waypoint has four leases expiring this year at the Fawkner site in Melbourne, representing 0.4% of income. Two lease renewals have been completed to date with a small negative reversion of 2% on the Viva lease at this site and the Subway tenancy renewing at passing rent. Negotiations remain ongoing with the remaining two nonfuel tenants, and we expect to complete these in the second half of the year. The operating environment for our tenants remains positive with fuel volumes continuing to recover post COVID, strong fuel margins during the half and above trend growth in industry convenience store sales over the last 18 months. The Convenience and Mobility division of our major tenant, Viva Energy, delivered a 40% increase in EBITDA in the first half and also completed the acquisition of Coles Express in May, which allows them to directly capture convenience store earnings on around 700 sites nationally and provides Viva with a high degree of control over the future direction of this network. We also note that Viva Energy has announced the proposed acquisition of OTR, a leading independent convenience operator with 174 fuel and convenience stores and annual sales of more than $3 billion. The transaction remains subject to regulatory approvals, including ACCC, but if successful, the acquisition is expected to be earnings accretive and will also further to this five Viva's earnings away from fuel with OTRs per store sales being more than double that of the Coles Express network and the contribution of nonfuel sales to growth profit of Viva's Convenience and Mobility division expected to increase from around 30% to around 50%. With that, I'll now hand over to Aditya just to take you through the financials and capital management in a bit more detail.

Thanks, Hadyn, and good morning. Turning to Slide 9, which sets out the half year result. As Hadyn mentioned earlier, distributable earnings per security for the half was $0.0828. This was down 3.7% on the prior period, but we are well placed to deliver our guidance for the full year. The decline in earnings was a function of lower rental income as a result of asset sales and higher interest costs. These impacts were partially offset by fewer securities on issue following the buyback completed last year and contracted rental growth. Statutory profit for the half fell to $29.1 million, primarily driven by valuation movements on the investment portfolio where a net loss of $31.1 million was recognized this half compared to a net gain of $133.2 million in the prior period. Our management expense ratio increased slightly to 31 basis points, a result of lower asset values rather than higher costs. Non-property expenses remain in line with the prior period, demonstrating the team's focus on cost control in an otherwise inflationary environment. Waypoint continues to offer one of the lowest management expense ratios in the sector. Like-for-like rental growth was 3.2%, reflecting our fixed rent reviews of 3% per annum across 93% of our leases as well as stronger growth on CPI-linked escalations. Turning now to the balance sheet on Slide 10. The value of the property portfolio reduced to $2.9 billion. Over the last 12 months, the value of our 402 assets has declined in aggregate by around 5%, reflecting cap rate expansion of 39 basis points over that period. Otherwise, the balance sheet has been largely stable, reflecting a period of lower transaction activity. Gearing increased slightly to 31.1%, but remains at the lower end of our target range of 30% to 40%. Available liquidity at year-end was $100 million, and we are managing the balance sheet to ensure it retain significant headroom to debt covenants, which we've outlined on Slide 11. In the face of higher interest rates, our cost of debt has stepped up to 3.7%, resulting in a reduction in our interest cover ratio. Our ICR continues to also show healthy headroom to the 2x covenant. We expect our cost of debt to continue to increase over coming periods as favorable interest rate swaps mature and are replaced at prevailing market rates. Turning to Slide 12 to look a little more closely at our debt and hedging profile. A key feature of Waypoint's capital management approach has been to retain relatively high levels of interest rate hedging. This continues to provide our earnings with significant insulation from movements in interest rates. Some additional hedging activity was completed during and just after the half year and is noted on the slide. As a result, Waypoint is 93% hedged to the end of calendar year 2024. We will look for opportunities to further increase hedging in FY '25 and beyond, in line with policy and subject to market conditions. Our debt maturity profile remains well positioned with no maturities until April 2025. As usual, with the support of our lending group, we are evaluating our refinancing options and we'll look to deal with these ahead of expiry. I'll now hand back to Hadyn to provide a market and portfolio update and our guidance for the remainder of 2023.

The transaction market for fuel and convenience retail property remains challenging as outlined on Page 14. First half transaction volumes in terms of both number of transactions and overall transaction value were in line with the second half of last year, but were around 40% of the level seen from 2020 through to the first half of last year. We estimate that only around 1/3 of the properties [ listed today ] has actually sold with a strong flight to [ quality thematic as ] evidenced by the strong skew in the half towards metro properties located in New South Wales and Victoria, the transaction is actually completed in the first half. These assets and markets are typically low yielding, which partly explains the fact that the average yield on transactions completed in the half was 38 basis points lower than the second half of last year. More detail on historical transactions is provided on Page 15 of the presentation, which highlights the transaction volumes and yields on regional assets have experienced the most softening since the market peaked in 2021. Average transaction yields for all fuel and convenience assets have now increased by around 50 basis points from circa 5.25% to circa 5.75% over the last 18 to 24 months. Turning to valuations on Page 16. Around 20% of the portfolio was independently valued at June, with the remainder of the portfolio subject to directors' valuations. As I mentioned earlier, we saw a 12 basis point increase in weighted average cap rate across the portfolio during the half, which brings the total cap rate movement over the last 12 months to 39 basis points. Highway sites have proven to be the most resilient over this period with sites and capital cities and other metro areas being the hardest hit due to their relatively low yields. The table on the bottom right shows the impact that rising interest rates have had on cap rates in the sub-5% range, proportion of Waypoint's portfolio with a sub-5% cap rate falling from around 45% 12 months ago to around 35% at churn. As shown on Page 17 of the presentation, New South Wales, which is the largest proportion of Waypoint's portfolio at 31%, has seen the largest cap rate expansion of 60 basis points over the last 12 months, reflecting the fact that New South Wales had a relatively high proportion of assets previously valued from cap rates of 4% or less. Finally, before turning to the outlook for the second half of the year, Page 18 provides an update on leasing. As I mentioned earlier, 2 of the 4 leases expiring this year at Fawkner [ have been fund lost ] with Viva renewing at a 2.4% discount to [ passage ] and Subway renewing at passing rent. Two further leases are expected to be finalized in the second half. Given the relatively long lease term of the portfolio, only 5 fuel and convenience leases have required renewal across the portfolio since IPO with an average positive reversion of 1.2% and a weighted average of 2.1%. Five nonfuel leases have also been renewed with average negative reversion of between 5% and 6%. However, we note that 4 of these leases were renewed at or above passing rent with one material negative reversion of around 30% in late 2020, dragging the nonfuel average down. Looking forward, Waypoint has only one fuel and convenience lease expiring in 2024 or 2025 with 7 non-fuel leases expiring over the same period. These 8 leases account for only 0.7% of Waypoint's total income with the lease to Viva at the strongly performing Rouse Hill site in Sydney accounting for around half of this. It's worth remembering that fuel and convenience make up more than 99% of our income versus nonfuel tenants. Turning our focus to the next 6 months. Our key priorities are outlined on Page 20 of the presentation. Viva Energy's recent acquisition of Coles Express and the proposed acquisition of OTR, our transformational steps towards their vision to become a convenience retailer to sales energy rather than a fuel retailer that happens to sell convenience. The ACCC's provisional findings in relation to the OTR transaction are expected to be released on the 21st of September, which could be either a final decision or a statement of issues that would need to be addressed by Viva before the ACCC makes that [ finance ] decision. A positive determination from the ACCC would add 2 near- to medium-term implications for Waypoint. Firstly, as part of the submission, Viva has proposed to divest the operations at 23 sites in South Australia, including 14 owned by Waypoint, which collectively account for around 2% of our portfolio. We have not yet had any detail from Viva on how the sale would be achieved or the identity of the proposed third party or parties. But expect that we will enter into formal discussions on this if and when ACCC approval is granted, noting that Waypoint has certain consent rights in relation to any assignment of the relevant leases. Secondly, Viva has flagged to the market that it intends to transform suitable stores across their national network to the full-service OTR offer, and we expect that many of these stores will be on sites owned by Waypoint. We've had some initial high-level discussions with Viva regarding these redevelopments and Waypoint's potential role in funding them, but as yet do not have any clear sense of the quantum of capital required or the timing of the proposed redevelopment program. Again, we expect that such discussions will accelerate if and when ACCC approval is granted and we will further consider Waypoint's participation in the optimal funding mix for any capital required once we have further details on Viva's plans. In relation to capital management, more generally, we've commenced work in relation to refinancing our 2025 debt maturities, which comprised around 30% of our total debt book. As Aditya noted earlier, we're well positioned from an interest rate hedging point of view for the next 18 months with more than 90% of our debt fixed until the end of 2024, but we'll continue to assess opportunities to optimize our hedging profile in later years. Our security holders are always interested in plans for further noncore asset sales given our track record in this regard over the last 2.5 years. As previously indicated, about 5% of our portfolio is currently considered noncore, and we will continue to monitor market conditions for opportunities to dispose of these assets over time. However, given the subdued market conditions at present and the lack of any [ real buy depth ] in the market, we do not currently expect to make any material disposals in the second half of the year. The prevailing macroeconomic backdrop remains uncertain that Waypoint is well positioned as we enter the second half of the year with gearing at the lower end of our range and a high level of hedging. This underpins our guidance for FY '23 distributable EPS of $0.1648, which is unchanged and in line with last year. The key assumptions underpinning this guidance are outlined in the presentation. That concludes the formal part of the presentation today. So I'll just hand back to the operator to coordinate Q&A. Thank you, [ Tal ].

[Operator Instructions] Your first question comes from the line of Ben Brayshaw of Barrenjoey.

I guess I was just wondering if you could maybe provide some overarching comments on the 14 assets in South Australia, how you're thinking about those from a long-term ownership perspective? You mentioned on the call as well that you had the right of, I guess, consent in relation to [ novation ] or assignment lease. So could you perhaps just comment on what that involves as well, please?

Sure. So we do have -- for [indiscernible], which is what we, I guess, assume to be the most likely mechanism by which Viva would transfer these operations, we do have consent rights, which, I guess, effectively boil down to the financial standing of the proposed assignees. So it will all come down to the identity of that party and our view on the creditworthiness in effect. We don't know who that is at the moment. We do understand that they've had discussions with various parties in the market. I guess we just have to wait and see the identity of that party, our view on the creditworthiness, whether we're happy to have them as a covenant and whether we would require Viva to continue standing behind that assignment, which is a rise as well in many assignments situation. And in relation to the long-term ownership of [ those assets ], again, that would come back to the [indiscernible] of that party and I guess what we think is their strategy for both sites and how that strategy would position them in the market relative to the competition longer term.

Your next question comes from the line of Richard Jones of JPMorgan. Your next question comes from -- next question comes from the line of Leanne Truong of Ord Minnett.

Just on my first question or a follow-up from Ben's question. In terms of the South Australia assets, how many of them were in your, I guess, that 5% noncore asset sales that you had identified over the medium term?

I think there's a couple in there, Leanne, but we've actually -- I think if you look at our aggressive sales over the last couple of years, it's actually been quite South Australian heavy. So a lot of the weaker sites -- weaker performing sites in South Australia, we've already divested over that period, but there are a couple in there for [indiscernible]

So you think that number may increase potentially with, I guess, the VEA announcement?

Yes, potentially. I think VEA's looking at sites in South Australia that it needs to divest it makes [ sets at ] those sites would be the competing OTR offer would be the stronger one. So I think there is a chance that increases once we know -- again, it comes back to the identity the incoming party and the [indiscernible] For a particular site. But I think certainly, there's a risk of that number or a chance of that number would increase.

And just for my second question, I mean, obviously, it's still subject to ACCC approval, but do you have an idea of how much it might cost to potentially redevelop each site, so whether it's a stand-alone or extending, I guess, the [ shop rate for ] the QSR offering?

No. No, we haven't had any indications [indiscernible] on that. I think publicly, they've said average cost of $3 million, $5 million -- sorry, $2 million to $3 million per site. That's obviously an average across their portfolio. It will depend to a certain extent on what's actually proposed in terms of the expansion. A lot of their sites have vacant workshops and vacant stores next door that they can push to pretty easily in terms of expanding those sites to incorporate QSRs and a broader convenience offer. But that $2 million to $3 million is the only figure that we're aware of at this point.

Your next question comes from the line of Richard Jones of JPMorgan.

Thanks. And hopefully, you can hear me now. Sorry, Hadyn. Yes. Just interested in terms of the lease terms in relation to potential CapEx spend, just wondering if you can walk us through what rights you have in terms of can you approve or knock back any proposed developments? And then second part to that question would be how would a return be determined on the CapEx spend for you guys to participate?

Well, I think Halfway Creek provides a pretty good example of that, Richard. So on that particular property had 3 years to run on the lease, we've got a 15 -- an extension out to 15 years, a 12-year lease extension plus a coupon on the money that we spend. So I guess the way we look at it is both the initial yield we're getting on the capital we're spending, but also, I guess, the capital value implications of the longer term and an improved property as well. So we've sort of put all that into the mix. Obviously, we're a listed stock. So the impact on EPS is an important consideration. But also we're a property owner. So long-term return is really what we're looking at. So -- and the long-term return is driven by the income yield we're getting on the way through, but also what that lease extension does and the improved property does for the overall long-term IRR on the properties. So that's the answer to the second part of the question. In terms of the first which was whether we could knock back developments. I mean we do have overarching rights that nothing can be done to materially diminish the value of our properties, but it's hard to see how every development would do that even if we're not participating. So -- and not participating certainly an option for us. I forgot a tenant that's prepared to spend money on the properties. That's a good thing, and it's a good baseline for us to compare things, too. But clearly, if we could put capital to work and achieve a good return from that investment, then that's something we'd like to consider and we're certainly willing to do so with Viva over the next few months.

So it's one of the options as well if the return hurdles are not met, that you can still look to lock in a longer lease. Obviously, with the tenant investing in the asset. It's obviously a worthy thing.

Yes, that actually -- they have that right if they proceed with the redevelopment that we don't participate in. They have the right to extend the lease out to, I think, it's 15 years, but we don't have the right to enforce an extension, if you like.

Yes. Okay. And then the terms are just -- as is it just goes to a longer review period? Is it...

Yes.

Okay. Yes. Okay. Good one. And then just your view on markets. I know you had some good detail in the presentation. Thanks, but obviously, the rate of cap rate move in the second -- or in the last 6 months has been half of what it was in the prior 6 months. Just a view on where return expectations are going and how that may influence cap rates into the next 12 months?

Yes, it's a good question, isn't it? I think my personal view, assets are still trading, but there is that flight to quality. So private investors are still willing to park their money in these assets. I think with the shape of the fall curve, maybe we've seen we're close to, if not the top of that cycle. So I think -- and the fact that, that cap rate softening has slowed, it feels to me like things are slowing, I still think there's a bit more to go. I think maybe if we're looking at our weighted average cap rate of 4.4% across our portfolio, I think the market is implying a 6% plus cap rate, maybe somewhere in between that is sort of where I think things may end up as we currently see it today. But obviously, things can change very quickly as well. So if buyer sentiment changed materially or seller sentiment as well and we see a flood of transactions actually hit the market and sellers hitting back and change -- obviously changed pretty quickly. But I think sitting here today, that's sort of my gut feel somewhere between where the cap rate is now and where the market is implying our cap rate of about 6%.

Your next question comes from the line of Adam Calvetti of CLSA.

Regards to new leases either Viva or other operators, are you looking to include a clause for convenience store sales and fuel volumes mandatory disclosure?

I think the way our leases were and we're not positioned to be looking at new leases with other tenants at the moment, we're not involved in any developments or fund-through developments. So that really comes down to Viva, which is obviously a large -- the majority of our income. So we do see fuel volume data and margin data on a stock by stock basis across the portfolio at the moment. When it was -- when the leases were signed and the master agreement was signed at IPO, given our provision for the convenience store sales side of that, given that's controlled by Coles Express and seen as confidential. But there are -- there is a clause in the master agreement that allows for access to reasonably required information from the tenants. So I think our view is that now that our tenant controls the community store sales side of things that access to that data is a reasonable request, and that's something we'll be working through with Viva over the next few months as well as we talk through these redevelopments and I guess the broader relationship in the context of the acquisition of Coles Express and OTR. So short answer is Adam, yes, we'd like to keep that, and we'll be pushing hard to get that information if we can. Sorry, just to make a point of the highly confidential and not something that we can pass on to third parties in much the same way as the fuel information is we have access to that data. We're very conscious about confidentiality arrangements around it. And we haven't disclosed that to date, and we take the same approach on the convenience store sales.

Great. And just maybe dig into that a little bit more. Have you sought any like legal advice on actually obtaining what that cost could mean as to whether you'll actually be able to pay in the convenience store sales?

No, we're not at that point yet.

Your next question comes from the line of Adrian Atkins of Morningstar.

Just on those 14 sites in South Australia. I'm just wondering if the average lease term. And I assume most of those would be metro sites, that would be right?

Yes, they are metro sites, Adrian, and I don't know the average lease term off the top of my head, to be honest.

Yes, I'll have to come back to you on that one. [indiscernible]

Okay. No problem. Just a second question, if you don't mind. We've got full in property values and rising interest rates heading credit metrics. I'm just wondering, are you comfortable if there is a fair bit of development to be done just funding that from debt? Or are you looking at maybe a DRP or some sub debt or anything, any other options?

Good question. I think the challenge at the moment is that we don't know, as Adam touched on the scale timing, quantum of what that spend could look like. So it's a little difficult to plan for and we don't know the depth of the opportunity in front of us. Definitely, we've always targeted our gearing at that 30% to 40% range. And if you look historically, we've tended to be at the lower end of that range. And I think that's probably something that we would consider as appropriate as we head into the coming few years. So I think dependent on the scale and the timing of the opportunity and our level of participation that will probably drive our view on funding mix. So I think yet to come, but all of those options, including potentially ideally, what we'd like to do is obviously sell our noncore assets and funnel that capital back into the core portfolio. But we'll just have to see our transaction markets and the depth of the opportunity emerges over the coming months.

Yes. I think it's important to just remember the timing of the program, which is a key driver. This isn't something that is going to happen overnight. This will be something that probably happens over 2, 3, 4, 5 years. So I think that takes the funding pretty sure of obviously, we need to have a fair idea of how we're going to fund it, but it's not as of all the capital will be required on day 1. So that provides us with a bit of flexibility. As Aditya mentioned here, an option -- asset sales are an option, equities is an option depending on how that might be funded, it could be DRP. There's various ways that we will look at it. But again, just the timing of that program is really important to keep in mind from a capital point of view because it's not something that will happen overnight.

[Operator Instructions] Your next question comes from the line of Murray Connellan of Moelis Australia.

I was wondering whether you could just give us a quick update on your more longer-term thinking around previously set of strategy of diversifying away from fuel and convenience. Obviously, you remain a net seller of assets and arguably not necessarily the time to be acquiring in the direct market right now, given cost of capital. But just, I guess, on your long-term thinking, is that still the strategy?

It's still an option, Murray, but I think as [indiscernible] said, that option has sort of taken a back seat given recent developments. I think it's something we'll still think about longer term, but our near to medium-term priority is really on our existing portfolio. I think what's changed over the last 12 or 18 months is the fact that previously, we were dealing with a tenant that didn't control sites. It was in a joint venture or the joint venture partner for whom the investment was pretty small, and there was no real incentive to spend money on those sites. So I think Viva having taken control of the Coles Express side of things gives them a lot more control over their network and flexibility to do what they want to do and need to do to address the longer-term challenges that they've got. And obviously, with the acquisition of OTR, will help accelerate them really brings on a best-in-class operator, which around -- which they can do to what we hope would be a best-in-class network. So I think -- our thinking has certainly changed and the priority is very much on our existing portfolio. And ideally, if we can continue to improve our existing portfolio by selling noncore assets, investing capital into core assets that we think will survive longer term, then that's a pretty good story and a pretty good strategy. So different priority A is the existing portfolio, long-term diversification may be something we think about. But here and now, priority is very much existing portfolio.

We have a follow-up question from the line of Adam Calvetti of CLSA.

Just wanted to follow up on do you think it's likely if you're going to achieve a positive spread of returns to the current cost of debt on future developments or the rollout of CapEx.

I'm happy to take that one, Adam. I think that is largely going to come down to our negotiations with Viva and the commercial outcome. But I think it's fair to say, first and foremost, we are mindful of the earnings trajectory and making sure we're a reason -- we want to make sure that we continue to deliver strong distributable earnings. But at the same time, our focus is very much on long-term returns. And so Hadyn touched on earlier the Halfway Creek example where I think we struck a really good balance between the near-term coupon that we're getting on that development, but also the significant value that was generated through the 12-year lease extension. So I think it will be a combination of focusing on near-term returns, but also very much with the mind to that longer-term return profile of the portfolio.

Okay. And with the Halfway Creek redevelopment, is that 5.75% yield, would that be creating a positive spread in today's environment for you?

It's around neutral to earnings at the moment.

Yes. And Adam, I think there's a lesson there for us. I think striking a fixed coupon with [indiscernible] probably not the right thing to do. I think just given some of the delays you can have in these developments, you obviously open yourself up to risk on that. So I think there's a learning there from that for us as we discuss more broader opportunities with Viva.

There are no further questions at this time. I will now turn the conference back to Hadyn Stephens for closing remarks.

Just to say thank you very much for joining us this morning. I'm sure we'll be talking with a few of you over the next few days. If anyone else would like to have a one-on-one meeting with us, we're more than open to that. So please just let us know. And again, thank you very much for joining the call this morning.

This concludes today's conference call. You may now disconnect.