Charter Hall Retail REIT (CQR) Earnings Call Transcript

Good day, and thank you for standing by. Welcome to Charter Hall Retail REIT 2022 Full Year Results Briefing. [Operator Instructions] Please be advised that today's conference is being recorded. I'd now like to hand the conference over to Mr. Ben Ellis, Retail CEO. Please go ahead.

Good morning, and welcome to CQR's FY '22 results. My name is Ben Ellis, and I'm the Retail CEO for Charter Hall and Executive Director of CQR. Joining me this morning is Christine Kelly, Head of Retail Finance and Deputy Fund Manager of CQR. I would like to commence today's presentation with an acknowledgment of country. Charter Hall is proud to work with our customers and communities to invest in and create places on lands across Australia. We pay our respects to the traditional owners, their Elders past and present, and value their care and custodianship of these lands. Turning now to Slide 5 and our portfolio highlights for the period. CQR continues to deliver a resilient and growing income stream for our investors. The operating and financial performance of CQR has remained strong throughout FY '22. Operating earnings per unit were up 4% to $0.284 for the year, and distributions per unit were up 4.7% to $0.245. For the full year, we completed 480 leasing transactions, and we again achieved positive leasing spreads of positive 2.3%, up from 1.6% at June 2021. This strong leasing activity translated into portfolio occupancy of 98.5%, up from 98.3% at June 2021. Valuation growth across the portfolio was strong and increased by 13.1% or $498 million, reflecting the attractive nature of the portfolio and the benefit of active portfolio curation towards higher-quality assets generating higher-quality income growth. This drove a significant lift in net tangible assets up 22.4% to $4.91. Looking forward, we expect to see continued strong demand for convenience and long WALE retail assets as investors continue to see the value associated with their resilient income streams and inflation-linked rental growth as characterized in the CQR portfolio. As a result, today, I'm pleased to announce earnings guidance for FY '23 of no less than $0.286 per unit, representing growth of 0.7%; and distributions per unit of no less than $0.257, representing growth of 4.9%. Turning to Slide 6 and the REIT strategy. CQR's strategy is to be the leading owner of convenience retail property. We achieve this by enhancing the portfolio quality through a curation of assets we own, active asset management to drive strong rental growth and maintaining a prudent capital position through a strong and flexible balance sheet. The result of our strategy is that we will continue to deliver a high quality, resilient and growing income stream for our investors, benefiting from an increased exposure to CPI-linked rental growth and CapEx-efficient, triple-net lease long WALE retail convenience assets. Slide 7 demonstrates the active curation of the CQR portfolio. Since 2017, we have divested 28 noncore assets valued at $611 million. These assets were predominantly located in regional areas with single industry economies, had supermarket turnovers well below the CQR average and face both specialty and major tenant vacancy risk. The proceeds from these asset sales were invested into 8 high-quality metro and commuter-metro convenience-based retail assets dominant within their catchments. These properties benefit from high supermarket sales, strong specialty tenant rental growth and surplus land allowing for pad site opportunities. Most importantly, since acquisition, these properties have delivered unlevered returns of 10.8% with NPI growth of 3.5% per annum. We will continue to explore opportunities to curate the portfolio towards higher-quality convenience-based retail assets benefiting from higher quality and resilient income growth. Slide 8 outlines how delivering on our convenience strategy has also driven strong income growth through our major tenant partnerships. Supermarkets have always been and remain the cornerstone of CQR's convenience retail portfolio. That represent a significant portion of the REIT's income and with CQR's above-average turnover levels from both Coles and Woolworths drive significant footfall to our centers and support the trading potential of our specialty tenants. 5 years ago, CQR had 3 leading convenience retailers with Woolworths and Wesfarmers representing 98% of the REIT's majors income. Along with ALDI, these 3 tenant customers represented approximately 50% of the REIT's portfolio rental income, and there were no triple-net leased assets within the CQR portfolio. At the time, the percentage of supermarkets in turnover was a market-leading 53%, which even by 2022 standards is still higher than our peer set. In the 5 years since then, our supermarket sales have grown by 3% per annum, and the percentage of supermarkets in turnover rent has increased to a market-leading 62% with a further 18% within 10% of their turnover rent thresholds. Through active portfolio curation, today, the portfolio and major tenant rental growth profile looks significantly different. We now have 7 major convenience retailers that collectively make up 56% of portfolio rental income. And when adding annual CPI rent growth associated with the long WALE convenience retail portfolio to the average supermarket rent growth, our major tenants will deliver 2.5% rental growth in FY '23. The addition of long WALE convenience retail assets to the portfolio now means that 31% of our majors rental income is linked to annual CPI rent reviews and 28% of majors leases are CapEx-efficient triple net. Benefiting from the deep tenant customer relationships within the Charter Hall Group, we've actively curated the portfolio to increase our exposure to these major convenience retailers, positioning CQR to deliver stronger underlying rental growth from all tenant categories. Charter Hall's ability to access off-market opportunities like the bp, Ampol and Gull portfolios and to partner with other Charter Hall funds to diversify our exposure to leading major tenants is a clear competitive advantage. The CQR portfolio now stands apart from peers given the REIT's broader exposure to a more diversified pool of major convenience retailers with a lower CapEx intensity due to exposure to triple-net leases and superior long-term growth characteristics through the security of our high-quality CPI-linked rental growth. Turning to Slide 9 and our most recent acquisitions. In December, we're pleased to announce the off-market acquisition of a stake in 20 high-quality Ampol sites in partnership with Ampol. In June, we increased our exposure to Ampol through acquiring an interest in a Charter Hall partnership that owns a further 205 Ampol service stations. Importantly, these 2 investments introduce Ampol as another major convenience retailer to CQR's portfolio, increasing the funds income from CPI-linked triple-net leases and lifting the portfolio WALE. Ampol is now CQR's sixth largest tenant customer and represents 1.8% of portfolio income. Post balance date, CQR has also been successful in further increasing the long WALE convenience retail portfolio with the off-market sale and leaseback acquisition of the Gull portfolio in New Zealand. This portfolio of 18 properties was acquired on a very attractive 6.4% weighted average cap rate and has annual CPI-linked rent reviews, a triple-net lease structure and is predominantly located in metro and commuter-metro locations. Following settlement, Gull will be CQR's eighth largest tenant customer and represent 1.4% of portfolio income. These 2 transactions continue to grow CQR's long WALE convenience retail strategy and in doing so, enhance the growth and resilience of the REIT's income. All of CQR's acquisitions completed in FY '22, including the Woolworths developed and anchored Butler Central in Perth, were secured off-market by Charter Hall and directly from our major tenant customers, demonstrating the value of Charter Hall's management of CQR in providing access to opportunities unavailable to other REITs. Turning now to Slide 10 on ESG. CQR continues to be focused on managing our portfolio in a sustainable way that benefits the communities in which we operate and for our unitholders. We continue to make positive progress on our commitment to net zero carbon emissions by 2025. We now have 21 megawatts of solar installations commissioned, including 3 megawatts installed in partnership with Coles and Woolworths. We have also commenced our battery rollout program with 7 megawatts installed, maximizing our on-site solar utilization. CQR has also participated in Charter Hall's group-wide 7-year power purchase agreement with global renewable energy giant ENGIE to integrate grid supplied renewables with on-site solar. Now turn to Slide 11 and our social achievements. Our ESG commitments extend to recognizing the important role our centers play within their respective communities. Over the period, we continued to undertake a range of localized community initiatives. In particular, we supported the Murwillumbah community following the devastating floods, providing weekly lunches for 699 primary school students across 6 primary schools over a period of 12 weeks. Once again, we celebrated NAIDOC week across 74 schools and in collaboration with 1,300 students to acknowledge the importance of the history, culture and achievements of Aboriginal and Torres Strait Islander peoples. We also continued our important partnership with the Two Good Co., supporting them in their vision of making a difference to every woman and child impacted by domestic violence and to bring harmony and security to every Australian. All these initiatives support social value outcomes that build resilient, healthy and happy communities. I'll now hand over to Christine to talk through the financial results for the period before moving on to the operational performance in more detail.

Thanks, Ben. Our operating earnings and distributions can be found on Slide 13. We delivered operating earnings of $164.4 million or $0.284 per unit and distributions of $142.1 million or $0.245 per unit for the 12 months to 30 June 2022. This reflects growth of 4% and 4.7%, respectively, on pcp. Our operating earnings payout ratio of 86.3% accounts for adjustments to operating earnings for COVID-19 support and capital expenditure during the period. Absent of COVID-19 support, the payout ratio would have been 91%. Total net property income has risen 7.1% to $221.6 million. This income growth has been driven by same-property NPI growth of 3.5% and our off-market investments in Butler Central and Ampol portfolio in FY '22 and the full year impact of the bp New Zealand portfolio acquisition in December 2020. The 3.5% same-property NPI growth reflects strong specialty performance, delivering a reduction in loss rent and continued positive leasing spreads, coupled with the solid performance of our major tenants, resulting in both base rent and turnover rent increases. Finance costs and other expenses have increased, reflecting the net portfolio growth of off-market acquisitions, capital spend and valuation growth. Consistent with prior reporting periods, operating earnings includes recognition of income for those tenants that were provided COVID-19 tenant support. The $5.4 million of rent-free incentives agreed are included in operating earnings and have been capitalized. The $2.7 million of rent deferrals, offset by a $0.6 million increase in expected credit loss, has been included in operating earnings and recognized in property income. The $0.6 million remains unchanged from December 2021 and remains low, reflecting our strong debt collections. Only 0.3% of FY '22 billings remain outstanding, and over 70% of the deferred rent provided since FY '20 has been repaid. For the period, the primary increase in statutory profit is due to the positive valuation movements. A reconciliation of statutory profit to operating earnings and distributions can be found in Annexure 2 of the presentation. Turning now to Slide 14 and the balance sheet. Our total property portfolio value increased by $652 million over the year with positive valuation movement of $498 million and the $154 million of off-market acquisitions. Borrowings have increased $176 million primarily due to the acquisitions and capital investment offset by DRP proceeds for the period. The primary impact on other assets and other liabilities is the movement in derivatives. The NTA has increased 22.4% or $0.90 from $4.01 to $4.91. Over 80% or $0.74 of the NTA growth is driven by the strong valuation gains over the period with the mark-to-market movements on our interest rate hedges contributing $0.12 to NTA. Our key valuation metrics are shown on Slide 15. 100% of the portfolio was revalued externally as at 30 June 2022, with the portfolio value increasing from $3.6 billion to $4.3 billion. Portfolio valuation growth of 13.1% or $498 million was split 40% from income growth and 60% from cap rate movement, demonstrating the quality and resilience of the portfolio and our continued commitment to active asset management. The shopping center portfolio delivered 13.8% or $406 million of valuation growth; and the long WALE convenience retail portfolio, 10.6% or $92 million. Both segments experienced cap rate compression with 67 basis points compression in the shopping center portfolio and 36 basis points in the long WALE portfolio, resulting in a total portfolio cap rate of 5.2% as at 30 June. With continued income growth from our convenience-based shopping centers and the majority of our long WALE convenience retail having annual CPI reviews based on September 2022 CPI, we expect valuations to be well supported going forward. Slide 16 shows the key highlights of our capital management. Our $245 million of liquidity at 30 June remained strong at $187 million post the acquisition of the Gull portfolio in August. The weighted average debt cost over FY '22 was 2.7% with our forecast weighted average cost of debt for FY '23 increasing 50 basis points to 3.2%. The 3.2% is a reflection of existing 83% hedging in FY '23 and forecast BBSY of 2.7%, reflecting 3 months of debt already rolled plus 9 months forecast average of 2.9%. Multiple refinancing totaling $570 million over FY '22 reduced FY '24 maturities by $320 million with only $50 million outstanding in FY '24 with a weighted average debt maturity of 3.9 years. We also increased our debt capacity by $100 million. Weighted average drawn margin across the portfolio is now 1.5%. Our interest rate hedging reflects the rate putting in place proactive hedging in February this year at market rates. Hedging for FY '23 is at 83% with our average hedging over the next 3 years at 56%. We continue to monitor the hedging market to ensure that we deliver growing returns for our unitholders. Our balance sheet gearing remains low at 25.5%, and look-through gearing is at the low end of the 30% to 40% range at 32.1%. The gearing levels have increased approximately 1% following the off-market acquisition of the 18 Gull sites in August. We are comfortably within our gearing and ICR covenants. And during the period, Moody's reaffirmed our Baa1 issuer rating with a stable outlook. Now back to Ben to present the operational performance of the fund and our outlook.

Thanks, Christine. Turning now to Slide 18 and the portfolio summary. Whilst some COVID-19 disruptions continued in FY '22, the resilience of CQR's assets remain evident, and we continue to benefit from our strategy of being the leading owner of convenience retail properties. During the period, our shopping center occupancy improved from 98.3% to 98.5%. Portfolio MAT growth remained positive at 0.4% despite the impact of government-mandated store closures. This is a strong result when considering that 67% of the REIT's specialty and DDS sales are generated from Victoria and New South Wales, which were heavily impacted by mandated store closures between July and October 2021. Pleasingly, retail sales continue to rebound with Q4 FY '22 total portfolio sales growth of 13.8%, above pre-COVID levels. Portfolio WALE remained stable at 7.4 years following the off-market acquisitions of Ampol, especially leasing activity and majors lease extensions. As Christine has outlined, strong valuation growth coupled with off-market acquisitions has seen the portfolio value increased 18% to $4.3 billion. Importantly, the portfolio now has 19% of total income growth directly linked to CPI with a further 36% of total income growth indirectly linked to inflation through turnover rent mechanisms. Moving now to Slide 19, outlining our tenant customer composition in more detail. We are pleased to have added Ampol and Gull to our portfolio, increasing the diversity of our major tenant customers and increasing our total portfolio income from major tenant customers to 56%, strengthening the resilience and certainty of CQR's income stream. As mentioned earlier in the presentation, as a result of this active portfolio curation, major tenant rental growth is expected to grow 2.5% in FY '23, up from an average of 1.2% over the past 5 years, providing significant earnings benefit for CQR unitholders. Across the major supermarket providers, we remain well balanced between Coles and Woolworths and continue to partner with ALDI to expand their footprint within the portfolio. Wesfarmers now represents 7.7% of portfolio income with the successful acquisition of API. Importantly, when we look at our exposure to any one specialty retailer, it remains limited, and we retain a clear bias towards every day needs and convenience-based retail, food and services. Turning now to Slide 20 and our long WALE convenience retail portfolio. Our long WALE convenience retail assets represent 23.4% of CQR's portfolio value and 18% of total portfolio income. These assets are predominantly all triple net, meaning they're CapEx efficient and provide a true AFFO yield for CQR investors. Their rent review mechanisms are majority CPI-linked, delivering meaningful income growth to the portfolio with the long WALE convenience retail major tenant growth forecast to be 5.1% in FY '23. These long WALE convenience retail assets complement CQR's existing convenience-based portfolio and provide valuable diversification benefits, enhanced WALE and strong major tenant income growth. Turning now to Slide 21 and discussing our supermarkets in more detail. Supermarkets remain the foundation of CQR's convenience-based shopping center portfolio. During the period, supermarkets delivered MAT growth of 3.2%. The number of supermarkets in turnover remains high at 62% with a further 18% within 10% of their turnover rent threshold. In an ongoing and elevated inflationary environment, turnover rent and CQR's high percentage of stores paying within 10% of turnover thresholds provides valuable earnings growth exposure to inflation. This is unique to CQR and not as readily available in less mature portfolios. We continue to work closely with our anchor tenants, and during the year, we completed 9 new supermarket leases and term extensions. Charter Hall's tenant customer relationship focus has also helped Coles and Woolworths to deliver direct to boot facilities across the portfolio. We now have 95% coverage for these major tenant customers, and this ensures we capture online sales as part of our partnership with Coles and Woolworths. Turning now to Slide 22 and our specialty tenants. The desirable nature of our convenience-based centers saw continued strong leasing activity with 480 leases completed during the period, achieving positive leasing spreads of 2.3%. 169 new leases were transacted, delivering a positive leasing spread of 3.7%; and 311 renewals, achieving a 1.8% positive leasing spread. Our percentage of tenant customers on holdover remains low at 1.5% of total income. And pleasingly, our retention rate increased from 80% to 89% as retailers continue to see the attraction of our centers and their dominant positions within their respective catchments. While specialty sales were down 3.7% in the period, this reflects that 29% specialty tenant sales were impacted by government store mandated closures. Pleasingly, sales growth has rebounded strongly with specialty sales growth in Q4 FY '22 positive 2.9% or positive 9.8% compared to pre-COVID levels. Specialty productivity was moderately impacted by mandated store closures and trading restrictions, but remained strong at $9,894 per square meter. Similarly, occupancy cost remained stable at 11.5%. And when adjusted for COVID-19 rental support, the occupancy cost normalized to a very sustainable 10.8%. The portfolio's strong sales productivity, sustainable occupancy costs, continued positive leasing spreads and high tenant retention demonstrates the ongoing defensive and resilient nature of CQR's income. Now turn to Slide 23, our asset enhancement projects. Charter Hall's focus on active asset enhancement ensures we proactively invest in our centers and maintain their position as a dominant convenience centers within their respective catchments. We do this by investing alongside our major tenant customers and aligning our capital works with their store refurbishments that, in turn, help secure lease extensions and drive center MAT. Utilizing Charter Hall's strong tenant customer relationships, we recently replaced 8 Target stores with 10 high-quality tenants, resulting in a 17% uplift in rent. Our redevelopment of Rosebud Plaza in Victoria is now well underway to deliver a new Woolworths and Dan Murphy's as well as an improved shopping experience for their community. We also proactively unlocked additional development opportunities on surplus land where site coverage is low and adjacent usages can generate additional income. During the year, we completed pad site food developments with KFC at Lansell Square and GYG at Campbellfield Plaza in Victoria. We've also accessed the in-house early learning capabilities of the Charter Hall Social Infrastructure team to add our third childcare development to the portfolio, further enhancing the amenity of our assets. Again, this demonstrates the value of Charter Hall's management and its multisector capabilities. And our capital works program continues to future-proof our assets through sustainability and asset management initiatives that generate real benefits for our tenant customers, communities and CQR unitholders. Now moving to Slide 24 and a look at our tenant customer relationships. Annually, we engage Monash University to survey our center-based tenant customers regarding their satisfaction levels within the CQR portfolio and their dealings with the Charter Hall team. For our annual CentreSAT survey, we again achieved a market-leading 95% participation rate from our tenant customers. Notably, our tenant customers ranked us first in likely to recommend for the second consecutive year. Additionally, we maintained a high satisfaction on all key metrics. And once again, our tenant customers told us that it is our people and the way we communicate that are our greatest strengths. Throughout the past 12 months, it's the Charter Hall team and the commitment to maintaining strong tenant customer partnerships that has been critical in the ongoing delivery of CQR strategy. I'd like to acknowledge and thank our team for their continued efforts. Finally, turn to Slide 26 for outlook and guidance. CQR's strategy remains consistent and is focused on being the leading owner of convenience retail property to deliver a resilient and growing income stream for our investors. As I've outlined today, we continue to enhance the portfolio quality through curation and active asset management, and this is essential to how we deliver growth. Our expectation is a strong MAT growth, positive leasing spreads and high occupancy levels will continue. We also expect our portfolio to benefit from direct and indirect inflation-linked rental growth and the CapEx-efficient triple-net lease exposure making up 28% of the portfolio. Barring any unforeseen events, FY '23 earnings per unit is expected to be no less than $0.286 per unit, representing growth of no less than 0.7% over FY '22 earnings per unit. FY '23 distributions per unit are expected to be no less than $0.257 per unit, representing growth of no less than 4.9% over FY '22 distributions per unit. That ends the formal presentation, and with that, I now invite questions.

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

I was wondering if you could comment on a couple of things, please. You mentioned that specialty occupancy costs have reduced to be below 11%. Obviously, tracking above 11% pre-pandemic. And I was wondering if you could talk about your expectations for those going forward and whether you think there's opportunity to extract positive reversion [ in resetting ] those?

Yes, Ben, look, we've maintained occupancy costs at pretty sustainable levels for a long period of time, and we feel that occupancy costs in the sort of mid-10% to 11% is a good spot for us to be in. As sales rebound post-pandemic, we'll be able to access positive leasing spreads as the REIT has done consistently for a number of years.

Great. And just secondly, around the hedging profile, I was wondering if you could talk about the average hedge rate year-on-year looking forward. I noticed that the weighted average hedge duration has reduced over the last 6 months. As part of that, could you clarify as to whether you've restructured any of your, I suppose, your hedge positions?

Yes, Ben, I'll quickly answer that one. We mentioned at our half year results that we took out some hedging in February, which increased our FY '23 hedging to 83%. We haven't done anything else in there, and that was at-market at no cost, mate. So that was proactive hedging back then.

And just to clarify, the look-through hedge rate, Ben, is 1.2%.

Our next question comes from the line of Grant McCasker from UBS.

It's Grant. Can you hear me?

Yes, Grant.

Did you clarify there, just following on from Ben's comment, the reason why we've seen a reduction in the hedge duration?

So the reduction in the hedge duration is the hedge that we took out in February was a hedge that matures in June 2023. So it's just the weighted average impact of that. So you can see our hedge is -- we are highly hedged in the next 12 months at 83% and then drop down to 50% in the following period. You can see in the back of the pack the hedge profile as well. So we didn't restructure any existing hedges. We just put in a $325 million hedge that matures in June 2023.

And that was undertaken in February, Grant.

Okay. Then just looking at the guidance, I just want -- just on your turnover rent assumptions as we move into '23. How does that compare versus '22?

Yes, look, we're still seeing positive supermarket sales growth, as we're talking about. We don't see any reason for our turnover rent to drop off significantly as we move forward. And we're pretty positive about the supermarket environment given the inflationary period we're going through and the flow onto food prices.

Our next question comes from the line of Stuart McLean from Macquarie.

First question, just on the 5.1% NPI growth you're expecting into '23. Can you just confirm that that's underlying and excludes acquisitions?

So that's one point. Are you referring to the bridge at the back of the pack, Stuart?

I think on one of the slides there's a comment, Slide 20. It says 5.1% forecast FY...

That refers to our long WALE retail convenience portfolio, Stuart. So that's a reflection of both -- of the bp, Ampol, Gull and Coles distribution center, which have predominantly CPI distribution center of 2.75%, which gives us a weighted growth rate of 5.1% for the year.

And second question, just on the CapEx requirements going forward. You called out about the triple-net leases becoming the largest portion of the portfolio. Just what does that mean in terms of [ NC and TI ] spend and how it leads through to AFFO, please? Are we expecting a reduction in [ NC and TI ] relative to AFFO going forward?

So as far as what we adjust FFO to AFFO, so that's a combination of operational and leasing capital. You can see that's obviously a reflection of the volume of leasing that we do each year. So going forward, depending on the volume of leasing transactions, that's the biggest driver of that adjustment there. So at the moment, for FY '22 in combination with the operational capital, it's $17 million. We expect that sort of $15 million to $20 million going forward.

Okay. And then the final one, just talked about in your remarks some of the initiatives to enhance the assets. So I was wondering, what's the capital spend we should expect per annum going forward on these sorts of development-type initiatives? And what returns do you target as well?

Yes, sure. So look, we're feeling pretty consistent, and we think that our asset enhancement initiatives are sort of in the $20 million to $30 million a year. It will depend on what opportunities are in front of us. But looking at the pad sites, they're incredibly attractive opportunities for us. They're utilizing the low site coverage of our portfolio. It's on additional land or surplus land we have within our existing footprints. And realistically, returns of 10% to 15% are very achievable for those sort of opportunities, and we'll continue to look for them.

And then if we were to do a bit more of an average, so not everything will be the pad site, what's maybe at the lower end of your return expectations, Ben?

It's hard to say. It's opportunity driven. Look, we only got one significant development underway at the moment in Rosebud in Victoria, which is a replacement of Target to add Dan Murphy's and Woolworths to the shopping center portfolio. Look, it's obviously not a 10% to 15% return, but it's higher single digits, and we think that's a good place for us to target. And we'll be very proactive and make sure we focus on total return from all CapEx spend, and we'll be looking at things that are obviously more profitable for us going forward.

Our next question comes from the line of Sholto Maconochie from Jefferies.