Charter Hall Social Infrastructure REIT (CQE.AX) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Social Infrastructure REIT 2021 Full Year Results Briefing. [Operator Instructions] Please note that this conference is being recorded today, Thursday, the 12th of August. I would now like to hand the conference over to your host today, Mr. Travis Butcher, Fund Manager CQE. Thank you, sir. Please go ahead.

Good morning, everyone, and welcome to Charter Hall Social Infrastructure REIT results presentation for the full year ended 30 June 2021. Presenting with me today is Scott Martin, Head of Social Infrastructure REIT Finance. I'd like to commence today's presentation with the acknowledgment of country. Charter Hall is proud to work with our customers, communities to invest in, develop and create property assets on land across Australia and New Zealand. We pay our respects to the traditional owners, the elders past and present, and value their care and custodianship of these lands. The format for today's presentation is that I will start with CQE's key highlights and strategy. We'll then hear from Scott who'll provide an overview of the financial performance of the REIT. I will then return to cover operational performance, an update on the childcare industry, followed by a summary of CQE's outlook. We'll then offer the opportunity for questions. Turning now to Slide 5. Key highlights for the year were as follows: Operating earnings for the year were $0.16 per unit with an ordinary distribution paid of $0.157 per unit. From a capital point of view, CQE is well positioned with gearing at 24.5% and available investment capacity of $207 million, both after adjusting for contracted commitments. CQE has been active with its portfolio management, which has resulted in the weighted average lease expiry of the fund, increasing by 19.7% to 15.2 years, up from 12.7 years as at 30 June 2020. This has been driven by lease extensions during the year across 106 leases with Goodstart, CQE's largest tenant customer and other portfolio activities. During the year, we've achieved strong valuation uplift across the portfolio, which was a key contributor to asset growth of 13.3% and NTA per unit growth of 11.3%, resulting in gross assets of $1.6 billion and NTA per unit of $3.25 as at 30 June 2021. The portfolio is in a very strong position with 100% occupancy, a forecasted weighted average rent review of 2.9% and only 3.4% of lease income expiring in the next 5 years. In relation to the operating environment, which CQE operates in and the ongoing COVID-19 pandemic, childcare centers have remained open throughout various state lockdowns, demonstrating the essential nature of this industry. CQE has delivered a strong financial and operating results for the year and is pleased to announce FY '22 distribution guidance of $0.167 per unit, an increase of 6.4% from FY '21. Moving to Slide 6 and CQE's strategy. CQE's strategy is unchanged. Our aim is to provide investors with secure income and capital growth through exposure to social infrastructure property. We do this by focusing on enhancing income sustainability and resiliency to assets we own, having ongoing capital growth and undertaking ongoing portfolio curation. Turning to Slide 7. CQE has had an active year delivering on its strategy for enhancing income resilience and delivering capital growth. During the year, CQE secured 2 high-quality social infrastructure assets with an on-completion value of $202.5 million being the Mater headquarters and training facilities and the South Australian Emergency Services Command Centre. I'll talk to these acquisitions in more detail later. The extension of the 106 Goodstart leases in the year, an average of 13 years to 20 years was a key contributor to the increase in the portfolio. WALE has also increased CQE's weighting to fixed rental increases to 73.2% of the portfolio. During the year, CQE completed 10 childcare developments with a completion value of $69.7 million, introducing new quality properties into the portfolio and achieving valuation uplift upon completion. A further 9 developments are forecast to be completed by June 2022. As part of our active portfolio curation, divestment activity during the year included the sale of 44 noncore childcare assets for $85.3 million, including the remaining 20 New Zealand assets and the divestment of the 15% interest in the unlisted Charter Hall CIB Fund for $18.4 million. The portfolio is in very strong shape with the occupancy of 100% with a WALE of 15.2 years with minimal lease expiries in the next 5 years to 3.4% of portfolio income. Finally, we saw a strong capital growth coming through in the period, with valuation uplift of $119.4 million or 11.1% across the portfolio. I'd like now to hand over to Scott, who will provide an overview of the financial performance of the REIT.

Thanks, Travis, and good morning to everyone. A summary of CQE's full year FY '21 financial performance can be found on Slide 9. Net property income has increased by 7.6% compared to the prior corresponding period and has been driven by a combination of $3.4 million of organic rental growth and $1.7 million from net acquisition activity. Operating expenses increased by 3.4% due to portfolio growth and new acquisitions. And we saw a 24.9% reduction in finance costs due to lower levels of borrowings and a lower cost of debt in FY '21 compared to FY '20. There has been minimal impact on CQE's FY '21 earnings as a result of the COVID-19 pandemic with over 99% of rent collected during the period. CQE delivered operating earnings of $58 million, an increase of 13.5% on the prior corresponding period. The operating earnings per unit were $0.16 and ordinary distributions per unit were $0.157, reflecting a payout ratio of 98%. In addition to the ordinary distributions, a one-off special distribution of $0.04 per unit was paid as a result of the increased taxable income generated in FY '21 as a result of portfolio curation activity. The summary of CQE's balance sheet position at 30 June 2021 is presented on Slide 10. CQE's investment properties, inclusive of its 50% interest in the Brisbane Bus Depot joint venture has increased by 20.9% or $255 million since 30 June 2020, primarily driven by $119.4 million of property revaluations; $192.6 million of property acquisitions, principally comprising the acquisition of the Mater headquarters and the South Australian Emergency Command Centre; $24.9 million of expenditure on childcare developments; and these additions were offset by $82 million of childcare property disposals as a result of active portfolio curation executed throughout FY '21. The movement in securities is attributable to the divestment of CQE's 15% interest in the Charter Hall CIB Fund, which was disposed of in November 2020 for $18.4 million. And this was partially offset by a $17.4 million valuation gain on CQE's unit holding in Arena REIT. Other liabilities include $24.8 million of accrued acquisition and development costs. NTA has increased to 11.3% from $2.92 at 30 June 2020, to $3.25 at 30 June 2021, driven by the net property revaluations and the valuation uplift on the Arena REIT units. A summary of CQE's debt and hedging position is presented on Slide 11. During the current reporting period, CQE increased its total facilities by $100 million to a total of $600 million. CQE's debt facilities were drawn to $300 million at 30 June 2021. CQE has diversified funding sources with no debt maturity until May 2024 and a weighted average debt maturity of 4.1 years. CQE's weighted average cost of debt is 3.3%, which is calculated based upon drawn debt of $300 million and includes line fees on undrawn debt capacity and amortization of borrowing costs. Balance sheet gearing was 24.5% and look-through gearing was 25.6% as at 30 June 2021, adjusted for the completion of the South Australian Emergency Services Command Centre, together with the funding of the remainder of the childcare development pipeline. During the current reporting period, CQE has increased its level of hedging from $160 million to $225 million. CQE has a staggered hedging profile through to December 2025, with an average amount hedged of 68% at an average hedged rate of 0.54%. CQE has investment capacity of approximately $207 million, providing it with the ability to further pursue new social infrastructure opportunities. I'll now hand back to Travis to continue with the presentation.

Thanks, Scott. On Slide 13, we have CQE's portfolio summary. As detailed earlier in our strategy, we are focused on continued portfolio improvement and enhancement of income sustainability and resilience. Portfolio WALE as at 30 June 2021, has increased by 19.7% to 15.2 years as a result of a number of activities. This has included the following: agreement on the 107 new leases with average expiry of 20 years and 106 of these with our major tenant customer, Goodstart, this is in addition to the 40 new 20-year leases agreed in FY '20; 4 acquisitions and 10 completed developments with average lease terms of 17 years; and finally, 6 of 8 options of 5 years renewed, which extends their expiries from 2025 to 2030. Lease expiries within the next 5 years has reduced to 3.4%, highlighting the importance of the property and lease terms for the operators business. The remaining lease expiries for the next 5 years include only 1.6%, where the tenant does not have options to extend the lease. Moving to Slide 14. CQE's current portfolio is well positioned to deliver both income and capital growth with 72% of CQE's income underpinned by the top 5 tenants are all well capitalized. The portfolio is heavily weighted to the Australian eastern seaboard states with 80% of income derived from their states, and 78% of income derived from metropolitan locations. Childcare assets comprises 86% of the portfolio. And over the medium term, we expect this to reduce, the 50% to 70% of the portfolio as other social infrastructure assets are added to the portfolio. Fixed annual reviews continue to increase to 73.2% as at 30 June 2021, predominantly due to the completed Goodstart transactions. Rental growth moving forward is forecast to be 2.9%, comprising fixed increases, which averaged 3% and the balance of CPI increases. Moving to Slide 15 and some more detail on the recent acquisitions, starting with the acquisition of the Mater headquarters and training facilities. Settlement occurred in June 2021, with a purchase price of $122.5 million, reflecting a passing yield of 4.84%, was underpinned by a new 10-year lease to Mater with 2 5-year options and fixed annual increases of 3%. This transaction introduces a new and well-capitalized health care tenant into the CQE portfolio representing 8% of CQE's income. The second transaction completed during the year is the South Australian Emergency Services Command Centre with completion expected in November 2021. On completion, it will be leased to the South Australian Government on a 15-year lease with fixed 2.5% annual rent increases and 2 5-year options. Upon completion, this adds an additional government tenant to CQE's portfolio, enhancing the quality of CQE's income. Turning to Slide 16, an acquisition disposal activity for the childcare portfolio. Our curation strategy is focused on improving the quality of properties and tenants within the portfolio as demonstrated by the activity in the year. During the year, we settled 3 acquisitions totaling $12.6 million with an average value of $4.2 million and yield of 6.4%. These acquisitions have an average WALE upon acquisition of 20 years with annual rent reviews of 3% or higher. Consistent with improving the portfolio's quality, all the acquisitions are leased with listed ASX operators and are located in higher socioeconomic areas with an average SEIFA rating of 8. In relation to divestments, during the year, we divested 44 noncore childcare properties, including the remaining 20 New Zealand properties for a total value of $85.3 million at an average selling yield of 5.9%, and a 5.7% premium to book value. Properties divested typically are small with an average value of $1.9 million and size of 67 places. The WALE on these properties were 6.6 years and located in lower socioeconomic areas with an average SEIFA of 4. In addition, the property return on the New Zealand assets was diminished due to tax leakage in New Zealand. Turning to Slide 17. CQE took 326 childcare valuations during the year that saw an increase of 10.8% from the 30 June 2020 valuations. The Brisbane Bus Terminal was also independently valued, resulting in a 16.7% increase with CQE's 50% interest having now increased by $9.75 million or 19% since acquisition in June 2019. As can be seen from the bottom right graph, the value market transactions significantly increased during the year with sales of approximately $550 million compared with the previous year of approximately $300 million, which was impacted by COVID-19. Yields have continued to compress with average transaction yields of 5.5% in the second half of the year. There has been a significant number of transactions in metropolitan Melbourne in the last 6 months, where average yields of 5.2% were achieved with the number of sales occurring sub 5%. This reflects a combination of strong demand for long WALE assets in essential sectors with stable income and also the low interest rate environment. Strong sales that continued in July and August, which have included sales for a center in Sylvania in Sydney, which is 22 kilometers from the city with 3.7% yield and Morningside in Brisbane, which is 5 kilometers from the city with 4.98% yield. Turning to Slide 18. During the year, CQE completed 10 developments with a total valuation upon completion of $69.7 million and a yield on cost of 6.1%. All of these developments are in high-quality locations and provided a valuation increase of 8.8% upon completion. There are further 14 remaining properties in the development pipeline, and we are forecasting 9 of these to be completed during FY '22. The remaining properties have a forecast cost to completion of $37.9 million and a yield on cost of 5.9%. The completion of developments is a key focus for CQE as upon completion, these projects commence generating a return to CQE as well as delivering modern properties in strong locations. Turning now to Slide 19, the environmental, social and corporate governance. We are very focused on implementing sustainability initiatives across our portfolio. This includes climate resilience, social and community policy and responsible business and governance. In the FY '21 year, some of the REIT's key highlights include integrating sustainability initiatives in our new developments with some examples of design elements at our recently completed Elwood development shown on the right of this slide. Working with our tenant customers to deliver solar initiatives across our properties, recognition in the 2020 PRI Leaders' Group for climate reporting; and finally, completion of our Modern Slavery Statement. Moving to Slide 21, an update on the childcare industry. It's important to highlight the 2 key drivers of growth in childcare demand continue. Firstly, childcare remains an essential labor supply mechanism for the Australian economy, which has been demonstrated during the COVID period with additional government assistance provided to operators to remain open. Secondly, the significant learning outcomes that children obtain from attending childcare. There have not been any structural changes in demand as a result of COVID, with working from the home not having any negative impact on demand, other than in CBD locations and operators still requiring specialized premises in which to operate their services. Pleasingly, operator attendances have returned to pre-COVID levels and have been quick rebounds from any temporary attendance drops due to lockdowns in various Australian cities, underlying the resilience and the essential nature of the sector. Government funding amounting to $9 billion in FY '21 provides critical support for the sector. Additional government funding of $1.7 million per annum was announced in May as part of the federal budget to improve childcare affordability and workforce productivity. This was targeted at lower to middle income families and expected the benefit of approximately 250,000 families commencing in FY '23. Turning to supply. Net center supply levels for the year grew by 3.7% or 297 centers with 8,332 centers at 30 June 2021. The annual growth rate of 3.7% has slightly moderated in the prior year growth of 3.8%. There has been strong growth in Victoria at 5.2% and Queensland at 4%, with New South Wales below their national average of 2.7% growth. New center openings are at 159 for the first half of the year, compared with the 181 and 204 in the same period in prior years. Supply of childcare is linked to operator demand for new centers with minimal speculative development. It's estimated that across Australia, the vacancy rate at the property level is circa 1%. Moving to Slide 23 and the outlook. CQE is well positioned with resilient and growing income, low gearing and investment capacity of $207 million. We're actively pursuing opportunities in both childcare and the broader social infrastructure areas, consistent with the strategy. We will continue to see earnings and distribution growth in future years due to the full year benefit of acquisitions and completed childcare developments. We are pleased to announce, based on information currently available, continued tenant performance, and barring any unforeseen events or a further deterioration in the COVID-19 environment, the FY '22 forecast distribution guidance is $0.167 per unit, resulting in an increase of 6.4% on the FY '21 annual distribution. That concludes the formal component of our presentation. I'll now hand back to the operator and open the line to your questions. Thank you.

[Operator Instructions] There are no questions at this time. I'll now hand back to Mr. Butcher for closing remarks. Pardon me, your first question comes from Jeff Pehl with Goldman Sachs.

Just a couple of quick ones for me. Could you just maybe give an update of -- in the portfolio where the rent to revenue ratio stands? And also just for your childcare tenants, what the average daily fees are?

Great, Jeff. In terms of rent to revenue, we're currently sitting at around 11% and average daily fee's around $103 a day.

And then just, I guess, turning to just external growth and just your comments on social infrastructure. I mean you've seen very strong asset valuations in childcare and then also across the alternative space. Just -- I mean to you, what's looking attractive right now in that space? And where are things trading? And then just given that you do want to expand your exposure there by a lot over the medium term, just is there any hesitance there just given childcare's government-backed and you just have -- you went through the pandemic and your tenants were supported there? Just what are your thoughts about what's the most attractive across social infrastructure space?

Yes, Jeff, I think just to start out in terms of our growth where we're looking to take CQE, we've got a dual growth strategy. So we still are looking at opportunities in childcare, so we've been looking at a number of opportunities. It all comes back to -- obviously, this is similar to social infrastructure opportunities, getting properties in the right location with well-capitalized tenants and getting the leases that you're after. So we'll look to that in childcare. Obviously, both childcare and the broader social infrastructure sector are very competitive. So it's all about us trying to leverage relationships, try and source opportunities off market. And then we've got to obviously be conscious of hurdle rates to make it stack up. But I think you see in terms of from a childcare point of view, anything in locations that we really want to be in terms of the long-term land value growth are selling for sub 5%. When you look at some of the sales that have happened, which I referenced in the presentation, 3.7% in Sylvania, even the 4.98% in Morningside. So anything good quality, good covenant, long lease with good indexation is having [ a 4 in front ]. So it's challenging, but we've just got to be -- I think one of the benefits that we have is the broader Charter Hall transaction team and the reach that, that brings us. So we've just got to be out there wearing out the shoe while we're hunting down transactions. We still think there's plenty of opportunities there. We've talked about in the past around the financial strain on governments and universities caused by COVID, so it's just a matter of really trying to work with those bodies. And I think Charter Hall's got a very strong sale and leaseback record, so I was really trying to leverage that to get opportunities for this fund.

Are you seeing a lot of sale and leasebacks to those government tenants? I mean I know pre- -- kind of pre- and into the pandemic, you had mentioned that would be the case, there would be a lot of opportunities there. But have you seen much there yet?

Not as -- I think, still, the governments are so focused on -- the pandemic's still here and real. And we're all sitting at home in our living rooms today doing this. So I think the governments haven't really turned their attention to how do they fund what they've spent during COVID. So I think that's still to play out, Jeff.