Vital Healthcare Property Trust (VHP) Earnings Call Transcript

Thank you for standing by and welcome to the Vital Healthcare Property Trust FY '26 Full Year Results Call. [Operator Instructions] I would now like to hand the conference over to Jarrod Gill, Vital's Head of Investor Relations. Please go ahead.

Thank you, operator. As Vital Healthcare Property Trust's Head of Investor Relations, I welcome you all to Vital's annual results webcast for FY '26. On the call today and available for questions, we have Vital's Chief Executive Officer, Chris Adams; and Chief Financial Officer, Michael Groth. I will now turn over to Chris to present Vital's FY '26 results.

[Foreign Language] Thanks, Jarrod, and good morning, all. FY '26 has been a transformational year for Vital. The defining achievement of FY '26 was the successful transaction to internalize management. This was a milestone for the trust and creates a stronger platform for long-term value creation. We now operate with a fully aligned management structure, enhanced governance, and a remuneration framework directly linked to long-term performance. Importantly, internalization removes the external management fee structure and ensures future value created through acquisitions, development, leasing and capital management flow directly to unitholders. A key feature of internalization was also retaining the highly experienced trans-Tasman management team, preserving the specialist expertise and relationships that have underpinned the trust's success over many years. The reason to invest in Vital remains compelling. We benefit from favorable sector fundamentals driven by a growing and aging population, medical innovation and increasing demand for services. Public health systems continue to face capacity constraints, creating a growing role for private sector health care providers; superior long-term earnings underpinned by long-duration cash flows and indexation; strong relationships with leading health care operators; high-quality health care infrastructure remains scarce, highly specialized and difficult to replicate; and a significant pipeline of future growth opportunities embedded within the business. At current trading levels, the trust also presents an attractive entry point, trading at a meaningful discount to NTA despite stable portfolio valuation metrics. Beyond internalization, FY '26 was also characterized by execution on the operational front. Highlights included 4.1% growth in like-for-like net property income, refinancing of approximately $1.4 billion of debt on improved terms, strong leasing activity, asset recycling of circa $98 million, completion of 3 significant development projects with a cost of $229 million, maintenance of our annual distribution at $0.0975 per unit on an improved payout ratio and continued global leadership in ESG, with Vital again recognized by GRESB as global sector leader for listed health care property. These outcomes reflect both the resilience of our sector and the quality of our portfolio. I will now hand over to Michael to discuss the financial results and capital management in more detail.

Thank you, Chris, and good morning. I will now take you through the highlights of Vital's financial results and capital management position. FY '26 was a significant year for Vital. Net property income and AFFO were both up strongly. Distributions were maintained at a sustainable payout ratio and the transition to an internalized management model was delivered. Importantly, these outcomes were delivered while continuing to actively manage the balance sheet, refinancing debt on improved terms and preserving flexibility to execute on strategic initiatives. I'd like to touch briefly on internalization. As expected, the payment to internalize has been expensed to Vital's operating profit as a strategic transaction cost. Pleasingly, the forecast benefits of internalization are being realized and/or on track. For the 6 months to 30 June, $1.6 million has been realized in property management fee savings. General and administrative expenses, net of Northwest expense recovery income, are down $2.8 million. And development and leasing fee savings are $7.8 million based on activated developments. As a result, Vital's management expense ratio is 53 basis points, ahead of our 56 basis point internal target established at the time of internalization. Additional benefits, including savings from leasing, transaction and incentive fees, which were all linked to underlying activity and increases in Vital's property values, will be realized as these occur. Reported adjusted funds from operations was $0.115 per unit, up 10.5% versus the prior year, reflecting the benefit of the tax deduction relating to the internalization payment and associated equity raise. Underlying AFFO per unit, excluding that tax benefit, was $0.106, up from $0.1041 in FY '25. Distributions paid per unit are steady at $0.975, reflecting an AFFO payout ratio of 84.8%. Unpacking the result further, net property income was up 9% over the prior comparative period. General and administrative expenses, which includes Northwest management fees for the period prior to internalization, were down 12.3%. Partially offsetting these was a $9.1 million increase in net finance expenses, reflecting higher average borrowings, reduced interest capitalization as developments were delivered, and transition to income-producing properties and marginally higher interest rates after Vital's active hedging program. Vital's Australian earnings and cash flow also benefited from a stronger average Australian dollar at AUD 86.27 versus the prior year at AUD 91.21. Vital's underlying portfolio continues to perform well, with income growth being delivered from contracted and market rent reviews from essential health care infrastructure assets that generate stable and defensive cash flows. Net property income increased from $148.8 million to $162.2 million. On a like-for-like basis and excluding foreign exchange, NPI increased by 4.1%, reflecting strong leasing outcomes and rent review performance across the portfolio. This included a 2.9% increase from approximately 26% of the portfolio. Other key callouts include $1.1 million of additional income from increased occupancy, the benefits of property management fee savings that I mentioned earlier, foreign exchange benefits of $5.9 million from a stronger Australian dollar, partially offset by divestments that reduced income by $4.5 million, reflecting the $97.9 million of asset disposals that settled during the year as part of Vital's capital recycling program. Turning to Slide 10. Vital's balance sheet position remains disciplined and flexible. Investment properties increased to $3.5 billion at 30 June '26 with the portfolio weighted average capitalization rate stable at 5.54%. Gearing reduced by 250 basis points to 39.6%. This reduction was driven by the internalization settlement and equity raise, proceeds from capital recycling, asset sale, and valuation growth from rent reviews. Net tangible assets is $2.41 per unit. This reflects the internalization transaction and associated equity raise, offset in part by valuation gains and a stronger Australian dollar. The balance sheet is well positioned to support the development pipeline and ongoing leasing activity while maintaining capacity and financial flexibility. Slide 11 provides more details on Vital's debt position. We continue to benefit from strong support and appetite from our banking partners, successfully closing the refinance of $1.4 billion of debt facilities on improved terms. Total debt facilities are now $1.6 billion, and there are no debt maturities before April 2028. As mentioned earlier, at 30 June, gearing was 39.6%. Weighted average debt maturity was 4.3 years, and Vital had $165 million of undrawn debt facility limit and a further $97.4 million of committed but unactivated facilities. Turning to Slide 12. Vital has continued to actively manage interest rate risk, with an additional $540 million of protection added in later years. At 30 June, Vital was 80% hedged at 3.45%. Looking forward, contracted hedging provides 72% cover at 3.49% for FY '27 and 55% cover at 3.58% for FY '28 to which we will continue to look at adding additional cover. The average interest rate hedge duration was 2.4 years. The hedged rate shown excludes borrowing margin and the profile is based on current drawn debt. Additional potential hedging may also be exercisable at the counterparty's election. Our hedging program is designed to provide greater certainty over interest costs and to mitigate volatility in a higher-rate environment. It is one of the ways we are maintaining a disciplined balance sheet while continuing to invest in essential health care infrastructure that supports critical health services and long-term community demand. In closing, FY '26 was a year of strong financial execution for Vital, with internalization delivering to expectations. Active capital management improved Vital's balance sheet and increased flexibility. Unitholder returns grew via increased AFFO per unit and distributions were paid on an improved payout ratio. I will now pass you back to Chris to talk about Vital's portfolio.

Thank you, Michael. Turning now to the portfolio. One of Vital's key strengths continues to be the diversification of markets. We maintain exposure across major population centers throughout New Zealand and Australia and partner with many of the leading health care operators in both markets. Operator performance across the portfolio sits in line with the Vital benchmark of 50% rent to EBITDAR. Occupancy is sound at 97.2%, with significant leasing activity concluded in the period and RDX reaching [ practical ] completion in February of this year. The expectation is RDX will reach stabilized occupancy within circa 16 months postcompletion. Importantly, over 93% of leases are subject to fixed with CPI-linked reviews in FY '27, providing strong visibility of future rental growth. Quality health care infrastructure remains essential, and this continues to underpin both occupancy and leasing outcomes across the portfolio. A defining feature of Vital is the visibility of future earnings. More than 80% of our rental income is not due to expire until after FY '37. An average annual lease expiry over the next decade remains below 2%. During FY '26, we successfully leased, renewed or extended more than 27,600 square meters through active asset management initiatives and development. These metrics underpin the durability of future income. Sustainability remains an important feature of the Vital business. This commitment is evidenced within our development program. Endoscopy Auckland is our first Green Star project in New Zealand and the first private hospital in the country to achieve 5-star Green Star under Design & As Built v1.0. Also, RDX on the Gold Coast is now 6 Star Green Star certified. Newly committed projects at Coomera and Macarthur both registered to achieve 5-star Green Star certification. Our commitment extends beyond Green Star ratings and is increasingly informing how we assess and manage climate-related risks across the portfolio. We have continued progressing climate site assessments, helping us better understand asset-level exposure and identify opportunities to strengthen resilience over time. Development remains a key driver of long-term earnings growth and portfolio quality. Over FY '26, we completed 3 projects, along with the main works at Grace Hospital reaching practical completion post balance date in July, following a multistage development. The committed development program now stands at $247 million, with approximately $188 million left to spend, at an average forecast yield of 6.3%. Our approach remains highly disciplined. We invest where we have conviction in health care demand, strong operator relationships and locations capable of supporting long-term growth. The 2 major projects completed -- currently underway are Coomera Health Campus - Stage 1 on the Gold Coast and Macarthur Health Precinct - Stage 2 in Campbelltown, Sydney. At Coomera, we are establishing the first stage of what we believe will become a significant health care precinct opposite Queensland Health, new $2.3 billion public hospital, within one of Australia's fastest-growing regions. At Macarthur, we are continuing the next stage of the precinct strategy alongside the Genesis Cancer Care Integrated Center, with Ramsay to establish a short-stay surgical hospital in the new Stage 2 facility. Both developments demonstrate our strategy of partnering with high-quality health care providers in locations where long-term health care demand is expected to grow. During FY '26, we completed the Boulcott Hospital expansion, Endoscopy Auckland and RDX, as noted earlier, within the Gold Coast Health and Knowledge Precinct. These projects enhance portfolio quality, support our operating partners and create future earnings growth. The Boulcott and Endoscopy Auckland assets are fully committed in line with our longstanding brownfield development strategy, and at RDX, we are encouraged by the level of tenant inquiry and leasing activity across the asset. And finally, looking ahead, our priorities are clear. We will maintain a disciplined balance sheet, continue our portfolio optimization program, continue executing our development pipeline, including development leasing and leverage the benefits of internalization to drive long-term unitholder value. The health care sector fundamentals that have supported Vital for many years remain firmly in place. Accordingly, the Board has provided FY '27 distribution guidance of $0.0975 per unit, with distribution to be reviewed as development leasing progresses. Thank you for your continued support of Vital. We will now take questions.

[Operator Instructions] Your first question on the phone lines today comes from Vishal Bhula with Jarden.

Congrats on the great results. Just a couple of quick ones from me. Could you maybe just give a bit of color on your cost base and where you ended up versus the initial internalization proposal? I've seen that slide in the back of the pack, which has your annualized net recurring management expenses, but it's a bit different to the table you put out at internalization. So just want to get an understanding of, did you meet expectations or was there anything that came in other than you expected sort of thing?

So Vishal, it's Michael Groth here. Thanks for the question. So we are on track in terms of the expectations around our G&A costs, so general and administrative costs. The table that comes out in the original internalization proposal is ultimately our baseline. What we're trying to present in the appendix here is effectively how those costs played out for the first half of the year of the internalization. But again, 53 basis points, we're ahead of what our internal target was of 56 basis points from an MER perspective.

And then just the last one for me, [indiscernible] turn. Just in terms of your guidance, I know you're [ capping ] it to development leasing. But what have you guys assumed in terms of FX? Because it does look like half of your NPI growth for the year was on the depreciating NZD.

Yes. So we've assumed that FX is, broadly speaking, slightly higher than where it is sitting today in our internal forecasts, so around that $0.85 mark. So that's obviously one of the variables along with development leasing progress that is going to influence how we think about distributions and underlying results for FY '27.

The next question is from Nicholas Hill with Craigs Investment Partners.

Just following on from Vishal's questions around FX. How much of your current FX cash flow hedging position, or what is your current FX cash flow hedging? And how much of this year's currency benefit is expected to persist into FY '27?

So we've got about $20 million worth of FX hedging in place for FY '27 and a little bit into FY '28. That's covered roughly speaking, 70% to 80% of our cash repatriation. So ultimately, the underlying Aussie dollar cash that is expected to come through the results for '27. So from a hedging perspective, we're reasonably comfortable where we are from an FX perspective.

And can you talk to us a bit more about that 70% figure for RDX? Are there any large parts of that 70% expected to move into the committed occupancy figure in the next few months?

Yes. With RDX, we've made fulsome disclosures on it. It's a great building in a premium location, and that is what is under active engagement and negotiation. So that's not inquiry. That's parties we're dealing with in a robust manner right now. The Gold Coast market, more broadly, is one of the tightest markets in Australia, particularly in the A-grade premium end of the market. And there's limited direct competition for the type of building we offer, which is very flexible through right from Class 5 or office through clinical uses to laboratories. So we are working through that. The short answer is yes. Do we expect to land a number of those tenants? And we strongly believe in the proposition of 18 months to lease this building out, which is consistent with past disclosures on the asset.

And one more from me. Your portfolio occupancy decreased to 97.2%. Is this entirely RDX vacant space coming into the portfolio? Or is there something else contributing?

No, it's entirely RDX. In fact, the underlying portfolio ex-RDX sits at 99.5%. And we're moving to near full occupancy. And I think it demonstrates because if you look back, that increasing occupancy has come from the development product that we've put out there in the market. We've always been consistent over recent times that will lease up, it's high-quality space in good buildings. So RDX has stepped us back. But again, it's a high-quality building that we're confident in leasing. So it's purely a reflection of RDX.

The next question comes from Nick Mar with Macquarie.

Just following on the internalization benefits, appreciate the total number. But just in terms of the recurring number or the P&L number, can you just talk through that $19.1 million in that slide versus the $14.2 million talked about in the internalization docs and just what differences are there?

So the internalization docs themselves identified a total of about $20 million worth of benefits or value benefits of the internalization transaction. So that's a combination of, obviously, the transactions, which go through the P&L, so operating earnings and AFFO, things like base management fees, property management fees, leasing fees, et cetera. It also includes the value benefit from not incurring costs which would be capitalized, like development management fees, which obviously sit in the balance sheet and don't necessarily sit in the P&L. So when you sit down and look at that from an annualized basis, and again, referring back to the internalization documents, it was approximately $12 million that was expected to be realized through the P&L of that net $20 million. And we're tracking in line with that number when you take into account the development fees and the internal cost capitalization on our development projects.

So why is the P&L number, I guess, a bit different to how it would have been looked at otherwise? Because I guess if you sort of...

How do you mean?

Yes. So the cost incurred number that said -- independent report had was $15.1 million. How do we compare that number versus the $19 million?

The $19 million sitting in our P&L. So the $19 million sitting in our P&L at the moment is a combination of 6 months' worth of the preinterernalization versus 6 months postinternalization.

No, sorry, the $19.1 million when you've annualized the net recurring fees --sorry, net recurring management expenses in the first half.

Sorry, just let me find the number. Make sure I'm looking at the same one as you.

Slide 33.

All right, so the general and administration expenses number, which is, I suppose, the underlying $9.2 million, includes the expenses that were ordinarily incurred by the trust in its general day-to-day operation. So the normal G&A costs of an independent trust vehicle that existed prior to the internalization. So the $19 million number is effectively an aggregate of what was incurred to begin with, plus the incremental G&A from being an internally managed vehicle. So roughly speaking, Nick, there's [ $24 million ] per annum that is effectively the underlying cost base of Vital as a stand-alone entity. The G&A number that we're talking about in this slide on Page 33 is obviously the aggregate of the go-forward position, which is the aggregate of cost of running the platform plus the cost of running the vehicle.

And have you treated property OpEx stuff any differently here rather than having an income and taking them to the cost? Is it treated any different to prior expectations?

No different from prior expectations. To be clear, we capitalize some of our G&A expense as an internally managed platform. It is -- for the half, it's $1.7 million, $1.8 million. And that's, ultimately speaking, our development team and associated support there that is delivering our development projects that we have on foot at the moment. That's consistent with how we presented the internalization transaction and our expectations. But I will note, Nick, on that regard, we charge do an internal development charge to the project. So we are costing the development team and projects. So if you see a net 6.4% or 6.5% on a Macarthur or a Coomera, that's after we've provisioned the cost of those development resources for the project. So they are explicitly costed in the net return to unitholders.

And then in terms of those 2 small refurbishments that you've kicked off, can you just talk about what you're specifically doing there? Like is it pretty much all fit-out stuff? And what's the useful life of those refurbishments? I guess, if you're getting 6.5% and it's at 10 or 15-year useful life and it's not generating a huge amount of value as you depreciate it.

Yes. Firstly, the lease is a 30-odd years, and that's the benefit we have of these major renewal projects that you see at the likes of Wakefield and Grace. The tenant is committing to the infrastructure. The tenant put a material sum of money into the Wakefield project and also in terms of Grace. A lot of that cost is fit-out per se. A lot of it's also building services, et cetera, and leases vary across assets. But more often than not in those projects, the tenant is, in fact, responsible for the replacement, well, certainly the refurbishment and ultimately, the replacement of most of those items. So they're not from our perspective, ones that we have a 10-year life cycle and then we have a repair obligation in the main part. We are seeing -- that's an outcome that we will see for the long term.

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

Sorry if I missed it, but have you given any color on this comment around potential upside to dividend? What leasing do you need to see? Or maybe another way of putting it is, what outcome on RDX do you have in that guidance, given you've already got an unfavorable FX rate? What do you see as the outcome for RDX by the end of the year?

That's a very good question. So we've got a leasing profile. We expect roughly 18 months to lease that building to a stabilized occupancy, Rohan. So it was delivered in practical completion was February this year. So our budgeting forecasts ultimately run that 18-month profile through into our forecasts and our expectations to this year. So that's how we thought about it at the moment. We need to -- well, there's that 70% worth of demand and negotiations and interest at the moment, it's important to convert that as quickly as possible. And that will give rise to an opportunity to consider distributions once we've got full color around that question there.

So is that a straight line? So are you basically saying 30%-ish occupancy at RDX by the end of the year? Have I got those calcs right?