DEXUS (DXS) Earnings Call Transcript

Thank you for standing by, and welcome to the Dexus 2022 Annual Results Briefing Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Darren Steinberg, Chief Executive Officer. Please go ahead.

Good morning, everyone, and welcome to our 2022 full year results presentation. As an owner, manager and developer of property across the country, I'd like to start today's presentation by acknowledging the traditional custodians on the lands on which we operate and pay our respects to their Elders, past, present and future. Today, you'll hear from Keir on the financials, Deb on our funds business, Kevin on office, Stewart on industrial and Ross on investments and our development pipeline. We'll then finish with any questions you may have. We've achieved a lot this year in what has been a complex environment as we continued our strategic journey of becoming a more capital-efficient, multi-sector real asset platform. During the year, we further progressed our strategic objectives, which include generating resilient income streams and being identified as the real estate investment partner of choice. Our strategy is supported by the size of our balance sheet, access to pools of capital, group development pipeline with committed projects spanning circa 660,000 square meters and our commitment to sustainability. The acquisition of AMP Capital's real estate and domestic infrastructure business accelerates our strategy and positions Dexus as a leading real asset manager, underpinned by our best practice governance and risk management framework. Our leadership across ESG is globally recognized. For the third consecutive year, Dexus was the only real estate company to achieve a gold-class distinction in the S&P Global Sustainability Yearbook, retaining our leadership on the Dow Jones Sustainability Index. We delivered on our commitment to achieve net zero emissions by 30 June 2022 across the group portfolio. This was achieved through continued investment in energy efficiency and transitioning to renewables with the remainder supported by nature-based carbon offsets. We launched our Reflect Reconciliation Action Plan, which commences our RAP journey through acknowledging and connecting with Australia's First Nations peoples. We remain committed to progressing gender equality across our workforce and are proud to have been named as an Employer of Choice for gender equality for the fifth year running. I'll now pass you on to Keir to cover the financials.

Thanks, Darren, and good morning, everyone. Turning to the composition of the result. Our property portfolio delivered AFFO of $622.6 million. Excluding the impact of rent relief and provisions, office like-for-like income growth was 2.7%, and industrial like-for-like income growth was 3.1%, excluding business parks. Management operations FFO grew significantly as expected. We enhanced our disclosure this year with a new FFO category, reflecting distribution income that Dexus earns on its co-investments in pooled funds, such as DHPF and DXI. The trading business delivered $23.4 million of post-tax profits across 4 projects. The external independent valuations resulted in a total of $926 million or 5.6% increase on prior book values for the 12 months to 30 June. Cap rates drove 70% of the valuation uplift for the industrial portfolio, while they drove 55% of the uplift for the office portfolio. Turning to the results in detail. Office property FFO reduced due to divestments, including Grosvenor Place in Sydney, partly offset by fixed rent increases, the acquisition of Capital Square in Perth and nonrecurring income on development-impacted properties. Industrial property FFO increased due to the Jandakot Airport acquisition, recently completed developments and leasing success. FFO from management operations increased significantly, in line with the growth in our funds platform. Group corporate costs were up driven by the addition of APN to the platform and higher insurance costs, while net finance costs were down as a result of the interest reimbursement for the delayed settlement of Grosvenor and interest income from Capital Square. Income from co-investments in pooled funds grew meaningfully driven by our investments in DXI, DXC, AUHPT and DHPF. Net other expenses increased driven by FFO tax expense on the management business. Overall, underlying funds from operations grew substantially on the prior year, up 11.1% on a per security basis. Trading profits were in line with our expectations, and maintenance CapEx and incentives increased compared to the prior year. AFFO and distributions grew by 2.7% per security. This result is pleasing given our initial market guidance for distribution growth of not less than 2%, which was upgraded in the second half to growth of not less than 2.5%. Our distributions continue to be paid out in line with free cash, for which AFFO is a proxy. Revaluation uplifts drove a 7.5% increase in NTA to $12.28, which doesn't reflect the embedded value of our funds management business or our development pipeline. Moving to our capital management. At 26.9%, our gearing remains below the 30% to 40% target range. Combined with strategic asset recycling, this provides capacity to fund the acquisition of the AMP Capital platform and development opportunities. We have $1.9 billion of cash and undrawn debt facilities. Our percentage of hedged debt averaged 65% in FY '22, broadly in line with past periods. While lower than FY '21, material asset sales impacted the comparative period. We remain committed to maintaining prudent hedging positions through economic cycles. The weighted average maturity of our hedge book is 5.9 years, with more than $4 billion of hedging in place for FY '23. Thank you, and I'll now hand over to Deb.

Thanks, Keir, and good morning, everyone. As Darren mentioned, we have successfully continued to deliver on our strategy to grow and diversify our funds management business. Our fund investors benefit from our full service offering with multi-sector capabilities, a strong track record of performance and high standards of corporate governance that are externally tested and focused on delivering outcomes in the best interest of our investors. In an ever-changing market, we have been able to provide liquidity to those investors whose strategies have required it while also raising new equity for pooled and joint venture opportunities. Core to our ability to work with capital is understanding their investment drivers and ensuring we continue high levels of performance across all our funds, successfully outperforming the benchmark or to fund the investment strategy year-on-year. ESG continues to increase in importance as an investment hurdle. And as Darren mentioned earlier, Dexus is a global leader in sustainability, which aligns to our capital partners' ambitions and adds long-term value to the assets under management. Taking a look at the characteristics of our funds management business today. We have a large, diversified investor base with established Australian and offshore capital partners. Our diversified product suite includes unlisted institutional pooled funds, institutional joint ventures, listed funds, real estate securities, opportunistic capital, direct unlisted funds across all the major real estate sectors. We have an active investor relations strategy emphasizing broad and deep relationships with capital partners. And our recent market soundings have provided the following insights: Australia remains an attractive place for real estate investment. Investors are actively seeking investment opportunities. However, market uncertainty is causing a more conservative approach to capital deployment. And whilst logistics, high-quality office and health care are the preferred investments, opportunistic projects across all sectors are of interest. Some highlights for the financial year '22. All funds and partnerships have performed well with DWPF continuing to outperform over all time periods and DHPF and DALT delivering strong 1-year returns of 20.4% and 28.9%, respectively. We further diversified our investor base during the year with the addition of high net worth capital, family offices and new institutional investors. We continue to execute the investment strategies of our partners, including undertaking $2.5 billion of acquisitions and $2.2 billion of divestments. These included: the acquisition of Jandakot Airport industrial precinct for fund partners DXI and Cbus; securing the first 4 investments for DREP1; we also completed $1.8 billion of asset sales to fulfill the legacy ADPF fund redemption requests; and importantly, we progressed a number of ESG initiatives with DWPF named as the regional sector leader for GRESB. We look forward to another growth-oriented year ahead, and I'll hand you to Kevin for the office update.

Thanks, Deb, and good morning, everyone. Looking at office portfolio performance. FY '22 was another strong year of leasing activity in an operating environment that continued to present challenges. Occupancy increased from 95.2% to 95.6%, and our weighted average lease expiry increased slightly to 4.7 years. Our portfolio, particularly Sydney, continues to benefit from the flight to quality with 47% of new deals transacted involving customers upgrading quality of space. Incentives appear to have peaked across our key markets, and we expect them to begin moderating over the next 6 months. Sydney is showing signs of recovery with positive effective market rent growth over the past 2 quarters. The latest wave of Omicron combined with the presence of the seasonal flu virus has stalled the return to the office, which we expect to pick up again in the coming months. Moving on to our expiry profile. The space we currently have available is concentrated in Melbourne, where we have made progress in advanced negotiations with a number of tenants. Expiry levels are below our target threshold maximum of 13% per annum over the next 4 years. Our diversified tenant base presents limited concentration risk with our top customer, the State of Victoria, representing 3.5% of income and our top 10 tenants combined representing 17.2%. The flight to quality trend is evidence that businesses continue to value the workplace as a lever to attract and retain staff. As business leaders come to understand that flexibility is important in the workplace, they are also starting to see the impact that prolonged working from home is having on productivity, culture and equitable distribution of work. Our customer feedback is mixed. Many large employers are experiencing falling productivity, while some of the smaller, more agile organizations are reporting the same or better outcomes. Each organization is different, and every individual is different. Workplace models need to consider both going forward. Notwithstanding the evolution of work-from-home trends, organizations are still leasing space and were reluctant to reduce their footprint in the majority of transactions we concluded over the year. Further evidence of companies looking to the future within our leasing results include: customers utilizing their incentives to invest in fit out and engage with our strategic workplace team, Six Ideas; and strong interest in our development pipeline with large deals with Atlassian and at Waterfront and 123 Albert Street in Brisbane. Thanks. I'll now hand you over to Stewart, who will take you through industrial.

Thanks, KG, and good morning. The performance of our industrial portfolio will be leased over 700,000 square meters, including 373,000 square meters across our stabilized properties, and a further 330,000 square meters of development leasing, which Ross will talk to shortly. Occupancies hit a 4-year high at 98.1%. This was driven by leasing in the core logistics portfolios with occupancy at 99.6%, excluding the business parks. Effective like-for-like income growth of the core industrial portfolio was 3.1%, excluding the business parks. This result reflects the quality and location of our properties as rising transport costs increasingly favor well-located industrial assets as well as consistency and intensity of our leasing efforts. Incentives have declined markedly on last year to 13.5%, and our portfolio delivered a 1-year total return of 18.9% to the 30th of June and excluding the business parks was 24.1%. The portfolio was 6% over-rented at FY '21. Thanks to strong market rent growth and our leasing efforts, that position has now reversed to under-renting of 4%. Strong market rent growth creates the opportunity to grow income by resetting the rents on upcoming lease expiries across approximately 1/4 of the portfolio in FY '23 and FY '24. So let's have a look more closely at what's driving demand. Industrial take-up remains above long-term average as businesses invest in extra distribution space to cater for last-mile fulfillment. This demand is very broad based, including medical supplies, supermarkets and groceries, agri business, materials supporting transport infrastructure, general e-commerce and retailers investing in last-mile fulfillment. As I mentioned, transport costs have increased materially and now represent up to 50% of an occupant's costs compared to rent, which accounts for circa 5%. This reinforces the importance of having well-located properties given a strategically located facility can help to contain transport costs far more materially than the impact of rent increases on the bottom line. Dexus' development capability is supporting our customers' growth requirements across Australia and delivers quality new products to the Dexus platform. Thank you, and it's now over to Ross.

Thanks, Stewart, and good morning, everyone. It's been a busy period as we continue with our strategy of capital recycling to improve the balance sheet portfolio quality and provide capacity to fund our growth drivers, being the funds and development businesses. As you can see on the slide, at a group level, we were marginally net sellers in FY '22. For the balance sheet, we acquired $2.5 billion and sold $3.4 billion, which provides capacity to fund the $1.9 billion we committed to the development pipeline during the year. We also transact to improve portfolio quality. The capital recycling activities alone increased the portfolio allocation of prime by 140 basis points and improved WALE by about 12% or 0.6 years. While conditions for development have been impacted with high funding and construction costs, we still see development as a key driver of growth, and it contributed to long-term returns. As many of you know, developments can create value a number of ways. They can be highly profitable in their own right. We've delivered very healthy margins of circa 50% across the industrial projects in FY '22. Developments can also provide amenity and reshape a precinct where we capture value through adjacent leasing. And this is the case at 25 Martin Place where office space rents have grown about 20% over the re-lease space in FY '22, and we had a similar experience across the road with the lobby upgrade of 60 Castlereagh Street. And developments can create high-quality new product with stable, clean income streams like the Australian Bragg Centre with a 20-year WALE. Over the past 3 years, we've made a concerted effort to grow the industrial development business. And in FY '22, we've started to see the results with a record amount of completions. As Stewart mentioned, in FY '22, we delivered circa 330,000 square meters of high-quality product at an average yield on cost of 6.3%. We have very strong levels of development leasing, which would see us increase their completions in FY '23. Dexus is now positioned to be a key national partner for clients looking to invest in new facilities or to consolidate their real estate relationships with active land banks ready to meet new client briefs in every major national market. The group development pipeline covers circa 2.8 million square meters of industrial land to be developed over the next 7 years. The balance sheet currently holds about half of this pipeline with the rest sitting in our funds business. From a capital allocation perspective, the balance sheet currently has circa $1.9 billion committed into the development projects, and this represents just under 15% of the portfolio. At the half year, we provided some guidance around the embedded margins in the development pipeline. And while higher interest and construction costs have impacted likely margins, the book remains profitable, and we continue to activate projects, many of which have long lead times and we intend to retain our long-term interest in. Derisking projects has also impacted margins. Projects like Atlassian Central are 100% pre-committed with the design and construction contract in place with a Tier 1 builder. Taking current market assumptions and the pipeline is expected to generate development margins in the mid-teens, inclusive of funding costs. The focus for FY '23 is to continue the momentum in industrial and finalizing the pre-leasing for major projects at Central, Waterfront and 60 Collins Street where we also expect to commence predevelopment works in the next 12 to 18 months. Turning to trading. Well, the trading book delivered in line with where we guided the market to. $23.4 million of post-tax profits coming from a number of industrial projects. In FY '23, we expect a larger contribution from the trading book with the health care asset and a number of industrial projects being considered for sale. We expect to replenish the book through a combination of opportunities in the existing portfolio as well as new acquisitions, and these will most likely be in JV with the new opportunistic fund DREP, with which we jointly acquired 2 projects during the year. Thank you, and I'll now pass you back to Darren.

Thanks, Ross. Our strategy is supported by a fully integrated model of real estate ownership, management and development that is positioned to capitalize on underlying structural trends. Our capital is invested in an $18 billion high-quality real estate portfolio located in diverse markets, which generate stable core type returns. We believe that high-quality assets will continue to outperform secondary assets in the near term. Our diversified $26 billion funds management business enables capital-efficient investment alongside third-party clients with the platform growing by an average 16% per annum over the past decade. And our $18 billion development business provides embedded future value by improving the quality of the portfolio while providing inventory to grow our third-party relationships. Our next phase of growth will be underpinned by the acquisition of the AMP Capital platform. We are working with AMP and third-party stakeholders to achieve the conditions precedent, and the transaction is expected to take -- to complete in late September this year. Subject to the final assets under management that transition across, this transaction has the potential to add a further $21 billion to the group portfolio. It will bring with it an expanded product offering, new capabilities in infrastructure and an enhanced retail platform. As our investor base allocates more capital to real assets, we will provide a complete offering for third-party investors. Post the transaction, we expect the contribution of our funds management and trading businesses to increase from around 12% of earnings to closer to 20% of earnings. And we look forward to providing more details on our next Strategy Day that we intend to hold in 2023. So to conclude, Dexus has demonstrated resilience, growing or holding distributions over the past few years despite the impacts of the COVID-19 pandemic. Recycling assets has enabled us to maintain a strong balance sheet, giving us capital to fund our development pipeline and growing funds management business. We anticipate a challenging period over the next 2 years with rising interest rates, ongoing supply chain disruptions, a global energy crisis and geopolitical risks contributing to continued economic uncertainty. Higher interest rates are expected to impact our results this year. Based on current expectations regarding interest rates, continued asset sales and barring unforeseen circumstances, we expect distributions of $0.50 to $0.515 per security for the 12 months ended 30th of June 2023, below the $0.532 per security distribution delivered in FY '22. In the year ahead, we will integrate AMP Capital's real estate and domestic infrastructure equity platform. Looking beyond FY '23, we are set to emerge as one of the leading real asset managers in the Asia Pacific region, positioned to capitalize on underlying structural trends, and we are confident of continuing to deliver long-term value. Thank you. We'll now take any questions you may have.

[Operator Instructions] Your first question comes from Sholto Maconochie with Jefferies. Your next question comes from Ronny Cheung with Jefferies.

It's Sholto here. [ I have Ronny ] for the call. Just a couple of questions on the guidance blocks. Could you give us a few assumptions around what you are seeing in asset sales, cost of debt? It seems a bit below expectations for FY '23.

Keir, do you want to talk to that?

Sure. There are a number of moving parts when we think about FY '23 guidance. In terms of interest rates, we're expecting the floating rates range between 2.75% and 3.75%. In terms of asset sales, look, over the last few years, we've sold circa $1 billion, maybe a touch higher. So it's probably a reasonable guide to how we think about this year. And I think the other key piece is just around trading profits. We're indicating somewhere in the order of $50 million to $55 million of post-tax trading profits.

Okay. So that's a bit higher, like almost double on the trading profit, just a bit higher. So it just implies that some -- the asset sales [ are heavy ] and the cost of debt are the biggest driver of -- because [ cumulatively ], you've got the asset sales coming through from '22 plus more this year. It's as if cost of debt and those asset sales are the biggest drag on your guidance. Is that a fair comment?

Yes. I think if you -- I mean, if we look at -- through the last few years during COVID, we've either held or grown our distribution. So we're coming off a relatively high base to start with. Interest rates, as Darren said, naturally will have an impact. So the interest rates impact takes you to below the bottom end of guidance alone. Through that, we've got some earnings contributions through growth in the underlying portfolio and higher trading profits this year. And then outside of that, there are a lot of moving parts. As you mentioned, we've got the impact of assets that we've sold to date, the impact of assets that we're expecting we will sell through the course of FY '23 and obviously, the investment in the AMP Capital platform, which we're expecting will be broadly neutral in '23 and then accretive from the first full year thereafter.

And then just on leasing, leasing is quite strong. I mean, KG, you're saying incentives are stabilizing, coming down. Is that across all markets, including Melbourne? Or is it just Sydney prime or premium?

Definitely coming down in Sydney. And Melbourne, probably flat from where it's been. The other markets, probably flat. So we're not seeing them head north. Definitely coming down in Sydney though. But the other markets, flat.

Okay. And then just on the, if I may, touching on the capital side of things. Obviously, the [ WALEs ] are a bit backwards looking for the June number. What are you seeing on the transaction side? You still got a lot of assets to sell in terms of demand. And any softening in the sort of cap rates implied [indiscernible]?

I think at this stage, it's definitely slower than it was. It's very -- sort of the market has separated. Like if you've got anything secondary, it's going to be very, very hard to transact at anywhere near book values. However, we're still seeing very good demand for the better quality product, which is effectively what we would be selling.

And is it demand from Asia? Or [ do you know ] where the geography is coming from?

Still reasonably broad brushed. I mean I'm just very thankful that the product we're selling is at the better end of the quality spectrum. Ross has just got a bit more color there.

There's still [ a lot of capital out ] there. I think the question is just pricing. We're running an industrial sales process at the moment. We've got -- we're happy to sell it in line or in [ components ] with more than 50 people looking at that actively in the [ VDR ] at the moment. So there's a question of price, but I think there is still a lot of capital out there, which is quite encouraging for us.

Your next question comes from James Druce with CLSA.

Just to touch on Sholto's comments around guidance. Can you also provide some color around OpEx, like-for-like growth and occupancy in the office and industrial portfolios, please?

I missed the first part of the question. OpEx...

OpEx. So maintenance CapEx...

Sure. Look, we expect CapEx to be broadly in line with FY '22. We're still going to have elevated incentives even though they seem to be coming off a little bit. But we've got a lot of leasing to do, particularly in Melbourne. So expect that to be the same. I don't -- what was the other part?

Like-for-like...

Like-for-like. Yes, look, like-for-like is still going to be -- the leasing spreads improved half to half. And so we expect continued improvement in those spreads particularly as incentives come down, and like-for-like is anticipated to be positive. But we're not giving a number on that at this stage.

[indiscernible] industrial, very strong occupier demand across the markets we operate in. I think we're well-disposed in Western Sydney, in particular, when the M4 East tunnel comes through via Rozelle. It's going to drive rents higher, I expect. So like-for-like, again, no guidance, but expect it to be a positive outcome. And obviously, incentives are coming down. I think in Western Sydney, the core logistics portfolios were at 5% or under. Other markets, depends on the product, whether it's logistics or office park. But in the end, it's a downward trend for [ TIs ] and centers at this stage.

Okay. That makes sense. And maybe a follow-up to KG. So looking at the face like-for-like growth of 1.7% for office, you've increased occupancy 30, 40 basis points over the period. Your fixed increases [ are something ] around that 3.8% mark. Does that mean your leasing spreads are sort of negative 15-plus percent over the period? Or where do those face leasing spreads sit?

Yes. The leasing spreads were negative 14% overall for the total portfolio, negative 10% in Sydney. The face spreads are actually positive, 7% for the year and plus 10% in Sydney, which is interesting. But in terms of the like-for-like, the back end -- the second half was impacted by some one-offs. So we had write-offs -- amort write-offs for the big 3 offices at 100 Mount Street and [ a mall grade ] tenant at 80 Collins Street. So we had the benefit of most of that income during the year with lease surrenders and amort write-offs late in the period. Otherwise, I think like-for-like would have been about 3.8%.

Okay. So what was the dollar value of those?

The impact of that was about 1.1% to like-for-like.

Your next question comes from Richard Jones with JPMorgan.

Just a question in relation to the industrial portfolio that's been discussed in the press of about [indiscernible] that you guys are looking to off-load. Is that just a kind of recycling process? Or is there anything specific about the assets that is driving your sell-down?

Yes, Ross, do you want to pick that one up?

Yes. I think we've been pretty clear with the market that we're trying to put more of our capital invested alongside third-party capital, whether it be in funds or JVs. And to some extent, these assets are, I wouldn't say they're [ orphan ] on the balance sheet, but they're really the residual part of the industrial portfolio that doesn't currently sit in funds or isn't development inventory. So some of those are trading assets that we want to sell to deliver trading profits in FY '23, and some of those are assets that we think more naturally sit with either third-party capital or with other managers. So we're working through that process at the moment. And we have higher and better uses for that capital. We've got a very exciting development pipeline. You would have seen in the results, I guess, the opportunity we have in the -- just to recycle that capital into the industrial development pipeline, which is enormous in delivering very, very strong returns. So for us, it's really just about capital [ rationing ], capital allocation and driving better returns from the capital that we have.

Okay. That makes sense. Ross, can you just clarify the [ bus ] exit yield that you might be getting and then the redeployment yield on cost on industrial? [ If you could just call out what ] FY '22 was [indiscernible].

Look, it's probably premature to be telling you what we'd want to sell them because we have a lot of process, but we do have expected yield on cost. So I think if you look in the appendices for a lot of those development projects, we have a range of what we think the yield on cost is. And you can work backwards on what the cap rate is in the current portfolio. We disclosed the [ WALE ]. So that's probably a good place for you to start, and we're happy to have it offline, if it's useful.

That's fair. And just in terms of Waterfront, what are the hurdles required to commence that project?