Abacus Group (ABG) Earnings Call Transcript

Thank you for standing by, and welcome to the Abacus Property Group FY '22 Results Presentation. [Operator Instructions] I would now like to hand the conference over to Mr. Steven Sewell. Please go ahead.

Thank you, and good morning, ladies and gentlemen. Welcome to the Abacus Full Year 2022 Results Presentation. I'm joined today for the first time as our CFO by Evan Goodridge. Congratulations on your appointment and also Cynthia Rouse, our GM Corporate Comms and Investor Relations, plus K. Higgins from the finance team is in the room. I want to pay my respects to the traditional owners on the land on which we gather the Gadigal people of the Eora nation and acknowledge their elders, past, present and emerging. For those listening that have followed the group for some time, you will appreciate the transformative journey that we've been on and how satisfying it is for the whole team to have the results and the platform positioned as we have at the end of FY '22, a fantastic period of accomplishment for Abacus, now with over $5.5 billion of total assets conservatively geared and the vast majority of our investments contributing to our strong net income underpinning. We're pleased with the performance for the year and more importantly, for the outlook for the near to medium to longer term. As I'll touch on later in the presentation, the Storage King operating business and asset base is something that we're most proud of. And with the results, we've delivered record income growth from operating conditions the best ever experienced. This income growth has delivered strong valuation uplift for the over 120 locations now that Abacus owns or is developing in the Storage King business across Australia and in New Zealand. Pleasingly, too, given our balance sheet strength, we've been able to deliver strong funds from operation, FFO, back distributions for our investors and pay out a dividend at the end -- upper end of our payout ratio at 95%. Turning to the year highlights. In a challenging -- in a year of challenging market conditions, who can forget the 107 days of lockdown imposed on New South Wales this time last year between July and October 2021 and the COVID associated macroeconomic and social impacts that impacted markets around Australia variously and also across in New Zealand. Across this year, the group was successful in transacting on acquisitions of assets as well as disposals, raising fresh equity in March this year and extending and entering into new debt facilities all to great long-term effect in line with our strategic objectives. As I touched on, the self-storage operating conditions surprised on the upside with all manner of tailwinds contributing, many of which we still see today. And in this context, we deployed over $500 million into new facilities and green or brownfield sites that will drive our development activity in this sector for years to come. Similarly, our commercial portfolio is taking shape and proved extremely resilient by virtue of the asset's location and customer value proposition, which I'll expand on later. We transacted across the year on some superior assets as well, most notably being the 77 Castlereagh Street Tower, which later this year will become the new contemporary corporate office for Abacus. Over the last 4 years, since we took the strategic pivot back after FY '17, we've deployed approximately $3.5 billion including over $2 billion into self-storage. We differentiate our strategy by being a high conviction owner, manager and operator of commercial and self-storage investments. Continuing -- looking to continue to optimize and diversify these investments by market, period in the life cycle and long-term income growth potential. This, we believe, delivers Abacus Group and its investors as a long-term asset-backed income growth investment platform with a clear focus on these 2 sectors and the application of our quality people, capability and systems. During FY '22, we also continued our journey to embed sustainability strategy, our sustainability strategy into how we conduct business here at Abacus. Our people and culture are critical to us delivering on this business model, and we progressed a number of initiatives during the year that were designed to develop our people, enhance our culture including our first in-person whole of team off-site post-COVID. The results from our annual pulse survey were designed to gauge team morale, motivation and engagement and reaffirmed our efforts with the improved score achieving our target. We've also improved diversity inclusion and inclusion at Abacus with new female hires now increasing to over 50% this year and developing strong and positive partnerships with all our stakeholders remains a focus for us, which I'll touch on in the results as we're seeing from our commercial customer engagement strategy later in the presentation. Allied with our repurposing of Asset Management to focus on medium- to long-term plans for each assets are our ESG strategies. From an environmental perspective, we continue to make progress, and we're on track to achieve our board set targets by 2025. A large number of portfolio initiatives including gas and energy procurement, a platform building is a live platform established in early this year that drives continuous improvement for this energy efficiency with daily performance analysis that facilities managers can use to implement changes, revise sustainability KPIs across the asset management team and our outsourced partners, Knight Frank and JLL, solar farm investigations on the vast array of [ roofs ] we have in our Storage King portfolio that can offset the rest of the portfolio's carbon emissions as well as procurement strategies across waste diversion, a tender that's underway. At specific assets, we have LED installations as well as solar across many of the commercial assets and also water meter installation and monitoring in our retail assets. The acquisitions and realizations that we've achieved over the last 4 years has seen a qualitative and quantitative transformation of the commercial portfolio since FY '18. Shown here on the screen of some of our biggest and most notable investments starting top left and working down the page, the new jointly owned asset at industry lanes in Richmond in Melbourne, a tower we part-own at 201 Elizabeth Street in Sydney. Our most recent Edition 77 Castlereagh Street, which I said will be the new corporate office for the group by the end of the year. The nearly in the middle of the page there, the nearly renovated and reconfigured Yarra falls building in Abbotsford in Melbourne. Bottom left, 1 of our largest and longest owned assets -- jointly owned assets at 14 Martin Place; in the middle at the bottom, the 324 Queen Street Tower, which we've now moved to outright ownership; and finally, bottom right, our wholly owned North Sydney exposure at 99 Walker Street. These 7 towers alone account for almost 2/3 of our entire commercial portfolio value and each have a story and long-term strategic rationale. Importantly, in this climate, the customer profile and value proposition has seen a strong and growing income contribution from our commercial segment. As I mentioned, during the half, we announced the retirement of our long-serving CFO, Rob Baulderstone, after just shy of 20 years with the group. Rob's achievements across the years as a key support to both my predecessor and to myself were immeasurably valuable, with this trusted expert commercial support, especially in recent years as we planned and then implemented such a material transformation of the business. Rob being one of the most positive and proactive culture carriers across the entire business. In particular, I want to recognize the people leadership and mentoring qualities of Rob across many of people in the finance team, including Reiner Low, who is now our Head of Finance across its Storage King and even our recently appointed CFO, along with many others in the Abacus finance team. It is truly a testament to Rob's dedication and focus that these internal promotions were possible, and the group now benefits from 2 extremely talented directly experienced finance executives in key roles. On that note, I'll now turn over to Evan, no pressure, to talk us through the financial metrics of the business.

Thanks, Steven, and good morning. As Steven mentioned, the group has delivered an increased funds from operations of $160.9 million. This equates to $0.19 per security. The 2 key drivers of the increase in FFO were the deployment of capital into accretive acquisitions and the strong performance of our established self storage portfolio. The self-storage performance is noteworthy and FY '22 performance represented the first full year that we have owned the storage operating business of Storage King. The EBIT contribution of self-storage increased by 57.5% for the year, to $110 million. Our commercial portfolio also remained resilient throughout the period, with an increase in EBIT of 10%, equating to $96 million. The growth sits in a strong capital position. And our capital management strategy remains focused on limiting debt expiries in any 1 year and maintaining sufficient liquidity to provide the financial flexibility to pursue growth. Capital management highlights include increasing our debt limits by $700 million, raising equity via $200 million placement in March '22, maintaining adequate liquidity levels, and establishing new debt relationships to complement the existing strong relationships that we have already in place. During the year, we refinanced over $2 billion of debt facilities, resulting in a 4.7 year weighted average maturity with our significant expiry until FY '26. Again, this supports the group's solid and stable balance sheet position. Our gearing at balance date was 28.7%. And following the recent acquisitions of the remaining interest in 324 Queen Street, Brisbane and a further $47 million of self-storage sites, the group's gearing has now increased to 30.5%. This gearing remains at moderate levels and is below our maximum target of 35%. Post these transactions, Abacus still has approximately $375 million in acquisition capacity to provide the group both financial headroom and flexibility. The group's cost of debt for the year was 2.1%. With the changing interest rate environment in mind, we have prudently increased our interest rate hedging levels to over 3 quarters hedged in FY '23 with a weighted average hedge maturity of 2.9 years. The group is, therefore, somewhat insulated from rising rates compared to our peers. And as such, we see our cost of debt increasing to only around 2.75% for FY '23. The valuation uplift for the year was $345.5 million or 8.3%, taking the investment portfolio to $5.1 billion. The majority of the uplift was in self-storage with a 15.8% increase. These results are the realization of the disciplined commitment to capital management and the strategy given to growing self-storage as an investment class. This sector continues to outperform and continues to be the group's best engine of growth. I'll now hand back to Steven.

Thanks, Evan. And just turning to the operating performance in more detail across the 2 businesses, self-storage and commercial segments. By most measures, the self-storage operating conditions were some of the best on record during the year, with occupancy and rental yield delivering a record result. Combined with our acquired stores, properties that we've added in the last 24 months, we now total 91 properties of almost 500,000 square meters net lettable area with strong occupancy and rental outcomes. In addition, as you see on the chart, our stabilizing bucket comprises 33 stores, 15 of which have either been recently developed or expanded plus a future pipeline of 18 locations that will underpin our growth in years to come. I'm extremely proud of our achievements in this sector. We have long-dated exposure, we have a predominantly suburban and inner urban quality located portfolio. And most importantly, we have the operational expertise and a scalable platform; all fundamental attributes that points to long-term gains. Looking across the country and in specific markets, you can see here the market performance across the last 24 months, barely a wrinkle from the most extraordinary harsh COVID lockdowns seen in Victoria, New Zealand and last year, as I mentioned, in New South Wales. All proves our thesis that if you focus on strong demographic markets, income and populations, design, build or install the rightsized product, and apply operational expertise under a trusted national brand, the self-storage asset class will continue to prove to be one of the most superior on a total return basis. Our Storage King operating platform, now over 25 years young, is benefiting from being wholly owned by the group with our enhanced focus on people, systems and processes including investment into financial management and performance reporting systems, further support for our multisite operational management and disciplines, upgrading our online user interface, and importantly, as you see in the image, our national advertising and brand awareness tactical programs. In addition, applying active asset management to the physical locations, which includes upgrading the curb appeal, retail merchandise offer, accessibility for customers and also prominent signage and generally facility amenity, all of which delivers new generation -- new generation self-storage assets, which are designed in urban and inner suburban location closer to customers and providing a superior value proposition, which translates directly into economic return. The FY '22 year saw us complete on a vast array of growth levers in this area, acquisitions of new stores, acquisitions of existing Storage King stores, completion of major scale developments, in particularly in New South Wales and Victoria, [ Wynonah ] and Roval Dan in Melbourne, plus optimizing the footprint on offer at existing locations such as some of the major projects we undertook at Pymble and Adamstown. In addition, across the entire portfolio, we have a retail refresh program, which has been rolling now for over 3 years, which has seen a step change in the look, feel, user and customer amenity of our stores, something that's not finished yet. The most notable and most lucrative and long-term beneficial of all our multipronged growth strategy in self-storage is where we can create and deliver new product. According to our own concept designs, look and feel in the best urban and inner suburban locations. We have a positive skew towards this activity with now more than 18 stores at various stages from early planning, design, tendering and we're constantly on the lookout for sites that exist in a targeted list of priority locations we have predominantly in Brisbane, Sydney and Melbourne suburban areas or where we have deduced will deliver superior long-term and growing returns. Whilst each project is relatively small in nature, we do, however, note the current escalating inflationary effect on build costs in some areas, delivering around 10%, 20% to 30% increases and we're monitoring the resulting impact this will have on our returns. Turning to commercial. Our commercial portfolio is recording -- has recorded a very pleasing set of results for the year. Driven in large part by the actions taken over the last 3 to 4 years to focus our capital on better quality, better located assets with long-term income growth potential. It goes without saying that we're in volatile market conditions, which partly existed prior to COVID and have been seen to accelerate during and now if I can be so bold as to suggest that we are post COVID. Our commercial exposure, as we depicted at the outset of the presentation, is a superior mix and quality than the group has ever invested in. And combined with the active asset management, and lacing with refurbishment and facilities and operational efficiencies, you can see there the like-for-like income growth of over 8% is very strong. Year-on-year, we've had success in delivering on leasing strategies, micro leasing strategies and more holistically across various properties. We do acknowledge that our portfolio is bespoke, and we feel that our experience and quality of investment decisions is what differentiates us, driving the number and type of tenants plus location, amenity and building appeal. To that end, across the year, the team developed -- delivered a strong leasing result with above-average leasing spreads underpinning that like-for-like income growth of over 8%. In keeping with market practice in usual terms, the reviews linked to CPI are not prevalent currently in the commercial portfolio; however, we believe where possible, they will be introduced where it is possible to negotiate. Clearly, the investment to upgrade fit out and enhance many buildings has paid dividends in the success of the leasing campaigns as our tenant customers effectively vote with their feet in wanting to remain and often extend in our buildings. Abacus Flex is our flexible working offer, which presently operates at both 14 Martin Place and 99 Walker Street. And since launching in the early days of 2020, we now see strong uptake and more importantly, see this business as being an incubator of small- to medium-sized enterprise tenants that try Flex for a period and often graduate to direct leases within the buildings. As a result of this positive momentum, we are now installing Flex into other locations including our shopping center, mixed-use asset on the Gold Coast at Oasis and at Abbotsford, our newly developed building in the fringe markets in Melbourne. On this slide, you can see a pictorial composition of the portfolio as it stands now compared to back at the end of FY '17 before any of the transformational steps have been taken, and as you can see, a much higher proportion of core long-term hold assets, only a few of which were held historically and also a similar quantum, albeit different mix of 4 mixed-use assets that we now hold. To constantly validate our portfolio's long-term standing, we now have initiated a process of return projections and constant review of the risk-adjusted returns that exist at each asset. All the while aiming to have the most optimal risk-adjusted returns derived from every investment being a stable, active or development projects into the future. Our only 2 proposed developments at the moment are those that we have in partnership at 201 Elizabeth Street as well as 710 Collins Street with our respective partners Charter Hall and Walker Group. Now that we've completed our projects in Melbourne at 459 Church Street with Salta and 452 Johnson Street in Abbotsford, which we own outright. On the next slide, we've shown some detail of the thinking as well as planning and actions that we have underway across -- with a significant focus on our office asset management capability. Projects that have been tackled and completed to great effect, including our small property in Surrey Hills here in Sydney following the renovation and leasing with a 42% rental income uplift and the major reconfiguration we planned and have completed at our Johnson Street asset down in Abbotsford, which has seen a 24% rental income uplift and importantly sets that building with a long lease profile and new contemporary amenity and features. Here in the city in Sydney at 14 Martin Place, an active re-leasing program and introduction of the flex component has seen us with approximately 22% increase in the gross passing income of the building since June 2018, with an increase in occupancy to now being fully let. Incredibly pleasing and strong validation of our investment thesis into quality buildings in great locations that offer a superior value proposition for our tenant partners. Looking at our mixed-use retail assets. Our exposure here is quite limited and not at all homogenous given the asset mix and nature of the assets. Three of the centers, as you'll realize have been owned and managed for many years. None of the assets are development affected and variously have weathered the COVID impacts of the last couple of years differently. We didn't see a dramatic fall in sales levels even through COVID, given the predominantly nondiscretionary and services offer installed at the centers. And so we don't have dramatic year-on-year increases. For the first time, our leasing spreads have turned marginally negative, only just, and this is symptomatic, I believe, to the volatile and challenging inflationary and cost of living pressures being experienced across the country, clearly impacts that are not done yet. We note, however, at the Myer department store in Melbourne, we do have a CPI-linked rent reviews and we monitor all our leasing progress and outcomes going forward. As I've touched on, it was something of a year for capital recycling, culminating after the prior 2- to 3-year period where we transformed and focused our investments, selling a number of our smaller investments and recycling the proceeds into quality, larger and higher occupancy buildings such as 77 Castlereagh Street and increasing our share just in the last couple of weeks at 324 Queen Street from 50% up to 100%. The photo you can see there on the slide is our brand-new industry lines property in Church Street in Richmond, which we've proudly developed in conjunction with the Salta Group. Over 60% let with a number of leasing transactions on foot, this is a superb quality property that we are very proud to own. And similarly, down the road at Abbotsford, not far from Richmond, again, a spectacular end product that sets the building with a good strong tenant profile and more importantly, contemporary amenity and building features. We look forward to showcasing these 2 buildings with you soon. As I mentioned, the only other 2 projects we have at the moment are DA schemes that have been submitted on both 201 Elizabeth Street and 710 Collins Street with details expected to be delivered across the next 6 months. So turning to the summary and the outlook for the year in progress. In summary, the team has delivered on our transformation in spades and Abacus, we believe, is positioned well with a clear purpose and a positive trajectory in both our commercial and self-storage segment investments. Both businesses have performed well in the year completed June 2022, and we are confident to have each long-term income and capital growth prospects. To quote the famous proverb, we live in interesting times. Already interest rates have lifted from the record low rates of the previous few years, and our assumption is that they will go higher. Inflation is inexorably rising and this will increase pressure across all inputs to the economy, cost of goods, cost of wages, et cetera. This results in our cautious and we believe a watchful and cautious stance with constant vigilance on the demand levels that we're seeing across both the occupier markets in commercial and also in self-storage. We are well positioned. Our balance sheet is in pristine conditions and our sectors position us well and attractive over the medium to longer term. We thank you for your attention, and we are open to questions on the line.

[Operator Instructions] The first phone question today comes from Caleb Wheatley from Macquarie Group.

Steven and team. Thanks very much for your time this morning. My first question is just following up on what you concluded there, Steven, on your cautious outlook. You've obviously provided I guess your expected cost of debts throughout FY '23. Can you speak to what you might be expecting in terms of underlying growth across the commercial and self-storage portfolios given that more cautious outlook? .

Yes, I think what we've seen, even just in the July statistics is that the impact of the rising rates has clearly crimped consumer confidence, it's resulting in delays or extended periods for leasing transactions in commercial and also a change in customer behavior in our self-storage business. We would expect that we will moderate to much more normal levels in our self-storage business, around 5%, 6%, 7% type growth. And inflation linked largely growth, income growth across our commercial portfolio, given that we'll start to see the benefits of some of those investment programs that we've been able to conclude during the year.

That's clear. Second question is just around the hedging profile. So it seems as they've been able to put on a significant amount of hedging over the past 6 months. Looking at the fixed rate, particularly the next couple of years has changed a huge amount, may be just, may be to provide some additional color on have you been able to achieve the increase in hedging and maintain fixed rates at such a low level?

Yes, I think we took some actions back in the first period around April, May. And I think what we've been able to do to quite strong effect is be able to lock in some rates that are quite attractive from that sort of longer period. We originally had advices to the movement of interest rates in the years 1 and 2, the next 24 months, and then potentially declining in the last 3-, 4- and 5-year period. And I think what we're able to do proactively is address our hedging profile in sync with that and also project that potentially that drop-off in rates would occur at a later stage. So that enabled us to put in place those swaps for the years 3, 4 and 5 of our program.

Yes. Sure. And just to be clear, there was no sort of capital outlay to lock in any of that hedging?

In the first 2-year period, there was and that was contracts we took earlier in the year. But what we've been able to deliver is actually contracts that from a mark-to-market perspective would have cost us a lot more if we had have done it in the last couple of weeks. So we think that we've been able to position the book pretty well.

And what sort of capital outlay was associated with the hedging in years 1 and 2?

We're around $14 million to $15 million a year for that first -- for that 24-month period.

The final one for me was just on the outlook for development returns. So you flagged potentially up to 30% cost inflation coming through on the self-storage development pipeline. I think you've previously spoken to a yield on cost of 7% plus coming through that pipeline. You're able to maybe just discuss what's happened to the yield on costs given some of those inflationary concerns coming through, particularly if rental growth at this stage is enough to offset and where you sort of see that yield on cost moving forward?

Yes. We do see the rental yield lifting and most of the projects that we're doing are in higher rental markets. So the -- where we see the potential for higher rental. We do, however, predict that those development returns will drop probably between 50 and 100 basis points down to a sort of 6.5% up to 7%. So they're still quite healthy given the valuation and long-term income growth for the properties. But we do just notice that movement in those construction costs.

And is there anything that Abacus can do in terms of fixed price contracts, I imagine it's a bit more difficult with the sort of smaller part and site development in self-storage. But is there anything you can do to mitigate potentially some of those downside risk from construction cost inflation?

Not really. Although what I would point to is that this is a development pipeline that is entirely at our discretion. And of course, if there was to be meteoric rises in those construction costs in the years ahead, then we always have the potential to delay those projects. But we don't see it in that realm at the moment, certainly the increases.

The next question comes from Richard Jones from JPMorgan.

Steve, just a couple of questions. Just why do you pay money to put in below-market hedges when that looks like it's going to create an earnings headwind for you in year 3, given the step up from circa 1% to north of 3%. I'm just wondering what's the rationale for doing that?

Well, it was all about the forecast movement of rates, Richard, and the advice we had -- strong advice we had and certainly accorded with most of the market participants and that where the swap curve was heading was that we were facing a period of quite substantial rate rises. So we believe for a long-term stability, it is in the best interest to enter into those contracts.

I understand entering into hedges but just not quite understanding why you pay money out to enter into a below market hedge that becomes an earnings headwind moving forward?

Well, it's a point in the cycle. And I think what we see today is that actually those hedges that were entered into in the money. They're actually an asset on the balance sheet because of the mark-to-market today.

Okay. Just bigger picture, Steve. Clearly, that the storage business has been going phenomenally well. And we look at REITs around the world and compare how storage and office REITs trade, there is a massive spread between the 2 of them. and you seem to be trading, I guess, more like an office REIT rather than a storage REIT. Just wondering if there's anything you're thinking about that maybe on the corporate side that could increase the weighting to storage and perhaps try and get a more storage-based share price rather than what looks to be more an office-based price at the moment?

Yes, it is something that obviously we monitor and take advice on, Richard. And I think your back of the envelope analysis does accord with ours that we do seem to track in line with office rates rather than there's only one storage rate. We are strongly of the view that our operating performance and balance sheet concentration in storage deserves more focus because of the results and what we believe is a good, strong long-term delivery. I suppose we're conscious that we can drive the income of the assets and prove up the balance sheet backing, and we believe we've done that on both sides of the balance sheet -- both segments of the balance sheet, and effectively, investors at the end of the day make their value assumptions. We are not negative at all on our commercial portfolio. In fact, we're seeing very strong growth at some of the assets as well as good long-term opportunities to invest in those assets. And equally, we continue to see at some of the targeted locations in storage, the ability to grow, materially grow our exposure in self-storage organically by creating that brand new product, which we've proven in the last couple of years, delivers an economic return that is far in excess of buying existing product. So we do -- as I said in the presentation, we have a skew towards creating that new product -- we see that in the right locations with the right fundamentals, the economic return is materially higher, and we'll continue to deliver that. But it's certainly something that we monitor and watch, Richard.

Steve. Just one final question. Just can you clarify what the average of move-in rate versus the move-out rate is for the storage portfolio at the moment?