BWP Trust (BWP) Earnings Call Transcript

Thank you for standing by, and welcome to the BWP Trust 2022 Full Year Results Briefing. [Operator Instructions] I would now like to hand the call over to the Managing Director of BWP Trust, Mr. Michael Wedgwood.

Good morning, everyone, and thank you for dialing in to our full year results webcast. Before I start, I'd like to acknowledge that this meeting is being held on the traditional lands of the Whadjuk people of the Noongar nation. I'd like to pay my respects to elders, past, present and emerging. BWP Trust acknowledges the traditional owners of country throughout Australia. We've released to the ASX this morning our full year results announced in our annual report and the presentation slides, which I'll go through now before taking questions. Andrew Ross, our Head of Property; and David Hawkins, our Finance Manager, are also here on the call and will be available to answer any specific questions at the end of the presentation. I should say that this is the first time we've actually been able to be in the same room together for one of these presentations for the last 2.5 years, so it's good. If we start on Slide 5, and that summarizes our full year outcomes. Total income for the year ended 30 June '22, was $153 million, which was slightly ahead of the prior comparable period. The Trust continues to be well positioned through 2022, with the significant majority of rental income exposure to Bunnings and other national, large-format retailers. There was portfolio rental growth during the year from scheduled increases and additional rents from completed developments, and that offset some loss of rent while properties are being repositioned from the divestment of Mindarie property and from a small amount of COVID-related rent abatement in the first half of the year. Distributable profit for the full year was $117 million, that was the same as the prior corresponding period. Included about $2.8 million in capital profits, and that was compared to $3.5 million in the prior year. On the basis that we pay out 100% of our distributable profit, we are utilizing some realized capital profits to maintain the distribution while we're repositioning some of our ex-Bunnings properties. The full year distribution for FY '22 is $0.1829 per unit, and that's in line with the prior corresponding period. NTA increased about 18% for the year, with increases in value of a number of properties in the portfolio from cap rate compression and rent increases. And most of that increase occurred in the first half of the year. The Trust property portfolio generated 3.3% like-for-like rental growth on an annualized basis. And that's reflecting the increasing quarterly CPI that occurred over the 12-month period. Portfolio cap rate reduced to a bit over 5% at 30th of June 2022, and that was from 5.65% at 30th of June 2021. And that resulted in a portfolio value uplift of about $372 million for the year. Our recent Bunnings Warehouse property transactions have included one at Mount Isa on a cap rate of 4.29%, one at Swan Hill on a cap rate of 4% and one at Nowra on a cap rate of 3.9%. They're all regional stores and reflect the continuing tight cap rates for Bunnings property. And that continuing strong demand through the year provided the valuation support for the portfolio -- from the positive portfolio revaluations during the year. Portfolio WALE at 30th of June '22, was 3.9%. And that's reflecting that a number of properties in the portfolio are either in the back half of the initial term or they're in option -- 5- or 6-year option period. In our view, it doesn't reflect the underlying risk of vacancies in the portfolio. Bunnings' business model cares a lot about location. Bunnings mostly determines the location of its properties, the building configuration and sets of lease terms. As a result, Bunnings generally occupy sites for a long period of time. It's really mainly changes in the products that Bunnings is selling and who it's selling them to that, from time to time, results in them needing to change locations in some areas. 14 market rent reviews were completed during the year, 10 of which were Bunnings Warehouse properties. Options on 7 Bunnings properties were also exercised. At 30th of June 2022, there were 73 properties in the portfolio and 97.5% occupancy. Gearing at year-end was about 15%, and the cost of debt at year-end was about 2.7%. While it's not clear to us what will transpire over the next 6 to 12 months in terms of the economy, we are assuming there will be continued volatility as central banks continue to adjust their settings and also consumers and businesses adjust to higher costs, which we've been seeing for a little while now. We think we're in a fairly good position regardless of the external environment. The Bunnings properties in the portfolio are mostly consistent with Bunnings' current format or are in areas where it's difficult to expand or find alternative sites. A number of the properties in our portfolio have and are continuing to benefit from increasing land values, and that's because of their location. While it doesn't necessarily directly impact valuations, which are based on cap rates, that certainly has an impact on potential future use in the event that Bunnings does move out of the properties. Over time, we are seeing more and better options for repositioning ex-Bunnings properties, and we expect that to continue to evolve. And even in recent times, we're not seeing any change in that regard. We're still seeing a very good level of inquiry for any properties that we're looking to reposition. 55% of the Trust income is CPI based, so we are positioned to benefit from higher inflation and for how long that remains to be the case. Rest of the income is mostly 3% fixed annual increases, so that provides good balance in the portfolio. Also, we're pretty comfortable with low gearing in this environment because it's not entirely clear what will happen to asset values over time. So we feel, with low gearing now, if there is some movement in asset values, it won't have a major impact. And vice versa if there's movement in property valuations, that may create more opportunities for us to grow. I'll just turn now to Slide 6 in terms of providing an update on sustainability or our sustainability actions. We've actually reported Net-Zero Scope 2 emissions for the year ended 30th of June 2022. For us, electricity usage is the main contributor for Scope 2 carbon emissions for any of our properties. Because of the structure of the leases, tenants are responsible for the significant majority of the electricity usage and the associated carbon emissions. The Trust's responsible for electricity usage in common areas at some of our properties and also electricity at any vacant properties or properties being repositioned. We purchased green electricity for 7 properties during the year where we are responsible for some electricity usage. And through that, we reduced our carbon emissions from 177 tonnes to 120 tonnes for this year just gone. We also purchased a small amount of -- or a small number of carbon credits to offset the residual emissions so that we could say that we are Net Zero, and we've had that independently reviewed. Through solar generation on some of those properties, we actually avoided 392 tonnes of CO2, which is well in excess of our actual emissions. Most of that electricity generation is utilized by tenants of those properties. We also -- the reason why we end up with some residual emissions is that the solar and power usage can occur at different times of the day. So technically, you can't offset them. So -- and that is the reason why we needed to buy some carbon credits just to offset those residual emissions. And just to finish up on that. The Trust doesn't have any Scope 1 emissions because we don't produce anything. And in terms of the Scope 3 emissions, we're still -- well, I think wherein probably most other companies or businesses are still working through what scope emissions are the responsibility for us, and that's not straightforward understanding that. If we now turn to Slide 8, we just show a summary of our results. And the one thing I will note, our management expense ratio increased very slightly from 0.3 -- or 0.63% to 0.64%, and that was really a function of the increased asset values during the year. For 2022, most of that increase in management fee was actually offset by lower borrowing costs. Other expenses remained pretty stable during the year. Slide 9 and 10 are also summaries of our financial performance. So I'll go to Slide 12. And we show the outcomes of 10 fundings market rent reviews that were finalized during the year. The overall outcome was slightly ahead of passing rent. 8 of those reviews were determined by an independent valuer, and we're a function of the available market evidence for each property. This was particularly the case for the Belmont property in Perth. The Fairfield Waters and Smithfield properties in Queensland, those reviews were negotiated. But again, were based on what market evidence was available to support the rent at that property. We certainly don't look at individual property outcomes as an indicator of the rent for the whole portfolio as there are and will always be some variation at a local level. But at this point in time, we remain of the view that the overall portfolio rent is broadly in line with market. We have a number of market rent reviews in determination at the moment, which we expect that will get resolved over the next few months. Turning to Slide 13. We show the like-for-like rental growth for 2022 of 3.3%. And we show that over -- we'll compare that over a number of years and also provide the breakdown of that. Certainly, we're starting to see the effective higher inflation coming through in that like-for-like rental growth. And I guess that will continue for as long as higher inflation is in the market. As probably most of you know, we have anniversary dates for our leases occurring throughout the year. So it does take time for the portfolio CPI to get closer to the headline inflation numbers because there's a bit of a lag while -- until such time as anniversary dates occur. On Slide 14, we just show the chart that we normally show in terms of cap rate trends. And that's remaining fairly consistent. And obviously, I've talked before about the most recent sales are still in the very low 4% range. I mean we don't know exactly what's going to happen to cap rates as we move forward. We would expect, if there is any adjustment in cap rates, it will take time for that to get reflected and possibly what might happen first is you get a slowdown in transaction activity. So that would also result in a delayed change in outlook for Bunnings properties, we think. Slide 15, which shows -- provide some information on that slide in terms of the revaluations in the period to June 2022. There were 14 independent valuations and 59 internal valuations. Cap rates on 22 properties tightened, 47 remained the same. And this is in the second half. And cap rates on 4 properties increased. The 4 properties where cap rates increased were Lismore and Rocklea. And they were both flood impacted earlier in this calendar year. And for a period of time, it makes sense to soften those valuations, and the other 2 were Wagga and Fountain Gate. And they're properties where Bunnings has indicated it may vacate and it's still a few years out. But once we understand Bunnings' intent, we do start to adjust the valuations until such time as we worked out their future use. Slide 16 just shows the independent valuation results. And you can see on that slide, the properties where cap rates have tightened. For the other properties other than [ what are there ], they're all well positioned and strongly performing Bunnings properties. But we're already -- we thought value to market. Slide 18, as we do normally, we just provide a snapshot of our core portfolio of properties and metrics around that. This is currently 65 properties that we would consider to be core in the portfolio and the balance of properties that are either being repositioned or all ones where Bunnings has indicated, at some point in the future, it's going to move from. And we -- I mean, that 65 includes, obviously, the Bunnings properties where we think Bunnings will be there for some time, and it also includes repositioned properties that we want to retain in the portfolio. Slide 19 shows the weighted average lease expiry profile in a graph. The next period when a number of properties will be getting to the end of their current option period or current first term is 2026. And as I've said earlier, from our perspective, we don't look at that as an indicator that Bunnings will be moving out of a number of properties. We look at each property individually. And then on Slide 20, we've shown the properties that are expiring in the next 3 years. At this point in time, Bunnings hasn't made us aware of any pending vacancies on properties on that list, so we're working on that basis. On Slide 21, we have shown the details of the proposed upgrade on the Lismore Bunnings Warehouse store. I mean we showed the same slide at the half year, but we've shown it again because it's information that's also in our annual report. I would say that construction or the starting of that upgrade did get delayed because of the flooding that did occur in Lismore and at our property earlier in the year, and we're -- the stores are back open in trading, but we still are waiting for confirmation from Bunnings when that upgrade will start. Slide 22, we've just shown there some changes to the upgrade terms for the COVID Bunnings Warehouse store. The -- this proposal was originally approved by the [ better -- Board ] in December 2019, and I think we mentioned it at that time. But Bunnings didn't proceed with the upgrade then, so they came back to us over a while ago to sort of revisit the upgrade, and we've agreed. Those terms that are on that slide. On Slide 24, we just, I guess, provide a brief snapshot of any properties that we're either repositioning or looking to reposition in the next few years. So Port Kennedy, we've had a leasing campaign underway for a little while to reposition that property for large-format retail. We're actually making pretty good progress. In this stage, we've got commitments in place for over 80% of the retail space. We're waiting for confirmation of DA approval, which we should get in over the next fairly short period of time. And after that, we can finalize details for construction and proceed with getting that property sold out. Belmont North, that property has been leased to the government as a COVID vaccination center, while we were sorting out its longer-term use. That lease ends this month. The property's rezoned and it allows for a supermarket to trade on the site as well as other retail and some other uses. We're still working through that in terms of what that property is going to look like, but we do expect to lodge a DA application this financial year to potentially significantly reposition that site for mix use. Morley, there's actually been a temporary lease also in place on that property to the government, but it was the Australian Electoral Commission, and that also expires this month. We also have a leasing campaign underway for a mixed-use development on that property, and we're making quite good progress on that. And hopefully, we can talk about that possibly next time we catch up. Hervey Bay. We have had -- Bunnings is still trading from Hervey Bay. It's building a new property next door. We have had a leasing campaign underway for a little while to -- with a view of repositioning that property for large-format retail. We currently have 90% of the space re-leased or committed to lease, so we're in very, very good shape. And we're just going through -- while we're still waiting for final DA approval on that site and we're just going through the final construction costs and whatever, but we're very happy with how that property's progressed and in terms of what that leasing profile is looking like. Albany is leased to Bunnings until October '24. We're still looking or reviewing some longer-term options for that property. In the interim, Bunnings has actually opened a Tool Kit Depot store at the property, which -- and we've -- it can -- Bunnings can do that within its existing lease. But we're not sure whether that will turn into a longer-term proposition for the property or not at this stage. I mean Tool Kit Depot is a new brand that Bunnings has launched which specializes in, well, as it says, for tools, for trades. So it's potentially, it's a good use for their property, and it's good for us to get exposure to that Bunnings brand as well. Fountain Gate is leased to Bunnings until 2025. I mean we have talked about that property before. It's a very, very well-located property in a very strong commercial and retail area, southeast of Melbourne. So we -- in the event Bunnings does move out in a few years' time, we do expect to get a pretty strong outcome with that property, and we're just working through the best use for it at the moment. And -- but it's a bit the same with Northland, which is leased to Bunnings until August '25. We're still working through how best to position that property unit. That property may have a shorter and longer-term best use. So we're working through that at the moment, but we would expect to be in pretty good shape in terms of what needs to happen next on that property when Bunnings moves out. And the last one on the list is Wagga, and that's still leased to Bunnings -- or Bunnings are still operating from it for a few years yet. We -- so I think we've talked about before, we are aware they're trying to finalize a DA on another property in Wagga. Our property is in a pretty strong commercial area in Wagga. So we're -- we'd expect to get a fairly good outcome. And also Wagga, as a regional center, is very, very strong with a lot going on there, so it's a good place to retain an interest from a property perspective. Turning to Slide 26, debt facilities. I mean I won't go through all that in detail there. One thing I will note, our hedging at the moment is about 55%. And we were high, I said -- or most -- all of our hedging at the moment is actually fixed rate bonds. We did have a bond that matured a few months ago. So that brought the hedging down to its current 55%. At the time it matured, the yield curve was very steep, so we didn't look to replace any hedging at the -- over that time, and we're just continuing to monitor that for any opportunities when it actually makes some sense to put a bit more hedging in place. I mean we're not uncomfortable with it at 55% because of our low gearing. But equally, if there's opportunities that make sense, we would probably take advantage of them because the yield curve is still moving around quite a bit at the moment. Slide 27 is just, I guess, a graph of our debt maturity profile. We have nothing maturing for a few years. And we -- 2 of our bank facilities, we can roll forward each year if -- we just need to negotiate it with the banks. So we're in reasonable shape in terms of debt maturity profile as well. Last slide is Slide 29, and that's our outlook. Look, from our perspective, we remain pretty well positioned operationally with the majority of our rental income from Bunnings and other large format retailers. Obviously, it doesn't matter what business you're in. It's not clear exactly what the economy is going to look like over the next 12 -- 6, 12 or 18 months, but our exposure is to very, very good business models, and we'd expect them to continue to trade pretty well in most economic environments. In terms of Bunnings properties, I mean, we're not expecting, in the short term, any significant sort of change in demand for Bunnings Warehouse properties. The Bunnings covenant is still getting very strong investor support. As I said earlier, what could happen is transaction activity slowdown if higher interest rates prevail and also higher construction costs prevail. And I think that would be likely to happen -- or more likely to happen before there will be any real step change in valuations, unless something happens in the market we're not -- obviously not aware of at the moment. We did show on the slide just a half yearly breakdown of the number of rent reviews over the year. Our focus for this financial year remains the same. It's mainly in terms of our existing properties and that's filling any vacancies in the portfolio, progressing all those store upgrades that I've already talked about, extending leases with Bunnings that makes sense to do so and also just completing those market rent reviews. That being said, I mean, we do continue to look for opportunities to grow. I mean for us, at very tight cap rates, we've found it harder to find a good valuation creating opportunities. But I mean, one side of volatility is it does create opportunities, so we're -- I guess, we're happy to participate if there is any disruption in the market. And finally, I mean, subject to there being nothing else COVID-related or any other major disruption in the Australian economy, the Trust expects to be able to have a distribution for 2023, similar to the distribution for the year ended 30th of June 2022. And as we've done in the last couple of years, if we need to, we will use a bit of capital profit to support that distribution. So that's all I've just wanted to go through with those slides. So I'll hand back to the operator to -- and we'll take any questions that you have.

[Operator Instructions] Your first question from Lauren Berry from Morgan Stanley.

First one from me. You did mention on the call that you had some flood impacts. Are you able to let us know how much that was and whether those tenants are back to paying full rent?

Yes, Lauren, and thanks for the question. Yes, the -- both the Lismore property flooded or everything in Lismore flooded and also Rocklea in Brisbane. I mean in terms of -- they're both back up and trading. I mean typically with -- if any Bunnings property floods, that -- generally, there's little or no sort of structural damage. It's more stock racking and, I guess, some of the equipment in stores, depending on how high the floodwater goes. I mean there's obviously insurance in place. And so they're both Bunnings Warehouse stores. There's insurance in place that the tenant has to pay or has to cover. And both of those properties were up and running in a fairly short period of time. And when we do -- we did have some insurance exposure at Lismore, and we're still sort of working through how much that was, but that's -- I mean, it's covered through self-insurance, so it doesn't have a short-term impact on BWP. So there's no short-term financial impact as a result of those flooded properties. And yes, they're paying rent.

Right. And obviously, the CPI coming through in FY '23 should be pretty good for your rent growth. But just wondering if those CPI reviews would be enough to offset the lost earnings from those 3 properties that are going to go vacant in the first half.

Actually, I don't have those 2 numbers to match each other. Look, actually -- oh...

I guess are you seeing positive NOI growth into FY '23 despite the vacancies?

We will see, obviously, growth in the portfolio, but there will be offset by vacancies. And the -- it just depends on the -- sorry, we're just getting some numbers as we're speaking. So yes, our overall rent for 2023 should be higher than 2022.

Okay. Cool. And then...

That's the long way around to get there.

Yes. No, that's fine. And the cost of debt, are you able to break up the margin versus what you're expecting on the base rate for FY '23 in your forecast?

Look, we don't disclose our margins because we have separate relationships with our banks. But I think what you should assume for margin -- well, look at the 5-year sort of bond rate or our margin on a 5-year bond, I mean, we would -- those margins are pushing out a bit at the moment, so we're obviously in a better place than that. Because any bonds that we have in place, we've had in place for a little while now. So we're certainly on the right side of the current 5-year bond rate as a sort of a proxy.

But we should expect a step-up in the all-in cost of debt for FY '23?

Yes, you will see a bit. I mean we would -- I mean, at the year-end, we were at 2.7%. So we'll be over 3% in FY '23.

Okay. Okay. Cool. And are you planning on divesting any assets for the capital profits released in FY '23? Or...

No, no.

Your next question comes from Lou Pirenc from Jarden.

Just a follow-up on your guidance. Do you expect a similar level of capital returns? Or do you think it needs to go up for that?

Look, it -- I mean, I -- it varies throughout the year, and it will vary based on the timing of upgrades. So just to say a number now I don't think is helpful. And we -- I mean, we find every year, we budget -- or if we think we need to, we budget a number in the -- by the year-end, the number's entirely different because it just moves through the year depending on the timing of when these things happen.

Okay. And then to follow up on Lauren's question, the 1.4% that you quote on your fixed or hedged debt, is that all in? Or is that before margin?

That's before margin, Lou, that's [indiscernible].

And can I ask, your CPI-linked rents, are they kept in any way? Or you get a full impact on CPI?

Andrew, you...

Generally, across the portfolio, it's not capped. But I think we've got 1 or 2 legacy cappings on CPI, but it's quite high.

Are they above 10?

No, they're not capped above 10. They're capped below 10. There's not many, Lou, at all.

Great. And then just to clarify, and I may be missing something. On Page 12, you talk about the 0.8% market rent reviews on those 10 Bunnings leases. But on Page 13, on the 4% of market rent reviews, it's 6.4%. What's the difference there?