Property For Industry Limited (PFI) Earnings Call Transcript

Thank you all for standing by, and welcome to the Property For Industry Interim Results Presentation. [Operator Instructions] Please be advised that today's conference is being recorded. And I'd now like to hand the conference over to your speaker, CEO, Simon Woodhams. Thank you. Please go ahead.

Good morning, and welcome to our 2022 interim results briefing. It's Simon speaking. I'm CEO of PFI. On the line with me today is Craig Peirce, our Chief Finance and Operating Officer. This morning, Craig and I are going to speak to the topics outlined in the content page on Slide 2 of the presentation. I'm going to begin by reviewing the highlights for the interim period and give an overview of the portfolio and its performance, along with the summary of the key leasing transactions throughout the period. Craig then is going to take you through the annual results and the sections on capital management and give a brief update on ESG. I'll cover off the market before reviewing our priorities, and then we'll close the presentation after which there's going to be a chance for participants on the call to ask any questions they may have. So if you turn to Page 4 of the presentation, let's hit it highlights. We're pleased to report on what has been a very solid 6-month period for us here at PFI, highlights that Craig and I are going to expand on throughout the presentation included, our resilient $2.2 billion portfolio delivered very strong rental growth with annualized uplift of 4.8% across $28.7 million of contract rent that was reviewed. We initiated our first share buyback program, buying 725,000 shares on market. We also post-balance date established a USPP facility, providing us with secure long-term access to funding. With stable gearing at 27.6%, we are well positioned to execute on our upcoming brownfield opportunities, including significant leasing progress made at Bowden Road. This activity has combined to deliver a stable operating result for the first half of 2022, with an interim profit of after tax $23.8 million. While our funds from operations was down slightly from the prior interim period, reflecting the divestment of Carlaw Park, our last major nonindustrial property, our adjusted funds from operation or FFO, was in line with the prior interim period. We turn to Slide 6. We've got a summary of the portfolio statistics as at 30 June. You can see that the company continues to own a diversified portfolio, 97 properties leased to 135 tenants. Pleasingly, the portfolio remains 100% occupied with a weighted average lease term of 5.32 years. The contract rent grew by $1.6 million to $97.2 million, and our deep focus on industrial property with the majority being held here in Auckland continues. Turning to Slide 7. We revalued 11 properties at the end of the interim period, resulting in gains on those properties of $18.9 million or an average of increase of 9.8%. As a result of these revaluations and portfolio activity, our passing yield remains largely unchanged at 4.44%. Our portfolio valuation sits at $2.19 billion. We would note there's been a less of transactional activity during the last 6 months, particularly with assets of scale. However, we expect to see this to spring up towards the end of this year and to the early part of 2023 as or should market conditions level out. Moving through to Slide 8, leasing. During the period, the team completed 19 leases over approximately 67,000 square meters of area for an average lease term of 5.4 years. Of those 19 leases, 4 were to new tenants and 15 were renewals. On average, just 0.2 months of incentive per year of term was required to secure these transactions, reflecting the current strength of the industrial market. Positive re-leasing spread of approximately 16% of annual passing rents was achieved. Which represented at an average 8.2% increase on the December 2021 market rents. Moving through to Slide 9. As I mentioned earlier, the portfolio is currently 100% occupied. And as the graph on the left-hand side illustrates, we have just 3.9% of contract rent due to expire during the remaining of 2022. Leasing demand remains robust and pleasingly, all of the remaining expiries for the second half of the year have either been secured or in advanced stages of negotiation with positive outcomes expected. Looking forward to the 2023 and '24 years, when we remove the upcoming redevelopment opportunities, the underlying expiry risk sits at 7.1% and 10.3%, which is in line with previous periods. We turn to Slide 10. The team completed 61 rent reviews across $28.7 million of contract rent. As mentioned earlier, we achieved an average annualized uplift of 4.8%. In the second half of this year, approximately 41% of our contract rent will be reviewed in some nature. The CBRE forecasting continued annual growth of around 5% over the next 5 years. We anticipate benefiting from these strong market dynamics. I'll now hand you over to Craig who will take us through the interim results. Craig?

Good morning, everyone. Thanks for tuning in. As Simon mentioned earlier, we're pleased to share with you a stable interim result for the company. Interim profit after tax totaled $23.8 million. Funds from operations are down 4.3%, [ 5.13% depreciated ]. Adjusted funds from operations are in line with the prior interim period of $0.0464 per share, and cash dividends for the half of $0.036 per share are in line with 2021 dividends. So let's dig into those numbers a bit. Please turn to Slide 12. On this slide, we take a look at net rental income, which is $47.6 million was up $1.6 million or 3.6% on the prior year. As Simon explained earlier, the first half of 2022 has seen PFI's portfolio delivered strong levels of rental growth, which has translated into a positive contribution to net rental income of $1.9 million. The net impact of acquisition and divestment activity also added a further $200,000 with some minor ups and downs making up the balance. So moving through to Slide 13. On this slide, we see how the first half of the year's activity has translated into adjusted funds from operations or AFFO. At a headline level, AFFO earnings were in line with the first half of 2021. Under the hood of that several results are a few moving parts. Net rental income, including AFFO adjustments, was up $2.2 million or $0.42 per share and a reduction in maintenance CapEx also provided a positive contribution as the tax. The main offsetting factor was an increase in interest of $2 million. This increase was a combination of a couple of factors. We've seen an increase in the company's weighted average cost of debt to 4.07% as of the end of the interim period from 3.4% as at the end of the prior interim period combined with a $54 million or 10% increase in average borrowings from net acquisition and divestment activity. Turning now to Slide 14. Looking at dividends, the PFI Board this morning resolved to pay a second quarter interim dividend of $0.018 per share, with the dividend reinvestment scheme not operating for this dividend. Second quarter dividend will take cash dividends for the interim period to $0.036 per share, in line with the 2021 dividends, resulting in an FFO dividend payout ratio of 79% and an AFFO dividend payout ratio of 87%. Positive results for the year-to-date and market conditions that are delivering strong rental growth now mean that we expect to declare cash dividends of $0.081 per share for the 2022 financial year at the upper end of our initial guidance range. Dividends of $0.081 per share would represent an increase of 2.5% on 2021 dividends and are anticipated to result in a dividend payout ratio at the bottom of PFI's dividend policy range, that range being 90% to 100% of AFFO on a rolling 3-year historic basis. Turning to slide 15 and looking now at the balance sheet. Here, we provide more detail on the change in value of PFI's investment properties, which includes assets held for sale and is valued at almost $2.2 billion. Breaking down the changes in the half, 11 properties were revalued at the end of the interim period, resulting in fair value gains on those properties of $18.9 million or an average increase of 9.8%. When combined with the revaluation changes of 39 Edmundson Street and 33 ((sic)) [ 330 ] Devon Street East as a result of transferring these properties to noncurrent assets held for sale, the unrealized net increase in the bay of investment properties for the 6 months was $19.5 million. One small property on Neilson Street, Penrose, is purchased and the divestment of a small property in Seaview, Wellington occurred during the half, and $5.8 million was deployed on CapEx, including seismic strengthening at Shed 22, a redevelopment of 59 Dalgety Drive, development at 47A Dalgety Drive and a sustainable refurbishment at 3 to 5 Niall Burgess road. So now turning to Slide 16, where we look at NTA. NTA increased by $0.062 per share or 2% from $3.34 per share at the end of 2021 to $3.96 per share at the end of the interim period, with gains on the values of investment properties in swaps driving that increase. Moving now to Slide 17. One other change to the balance sheet during the half was the impairment of goodwill of $29.1 million. Goodwill has tested from impairment by comparing the company's net assets for its market capitalization, adjusting for a control premium and cost of disposal. Based on this test and after cross checking with what's known as a value and use test, it was determined that goodwill was impaired and the full amount has been written off during the period. Notwithstanding this, the goodwill that arose from the merger with Direct Property Fund has been a very successful transaction -- sorry, the merger with Direct Property Fund was a very successful transaction for PFI. Looking at the results of that transaction, there's been a growth in rents since the merger of 35%, values of 124%, and those properties that were disposed of, we achieved a gain on sale of 18%. So turning now to Slide 19, capital management. First half of the year has been a busy period for capital management. And this year is trading at a 21% discount to NTA at the time, PFI announced that would undertake an on-market share buyback program on 25 May. End of June, around 725,000 shares or approximately 3% of the shares able to be purchased were taken up, and we got those at an average price of 2.4 or 1 14 per share. The buyback program has been paused from 1 July and recommence tomorrow on 23 August 2022, but we will continue to assess market conditions, their prevailing share price, available investment opportunities and all other relevant considerations. And we may suspend or terminate the program at any time, sounds like a legal disclaimer. So moving to Slide 20. This slide provides more detail on our strong balance sheet. We refinanced our $100 million facility with the P&C during the period, extending it from July 23 to July 24. And post balance date, a USPP facility was established with Pricoa Capital Group, part of the Prudential Financial Group, one of the largest U.S. insurance companies with $1.1 trillion of assets under management, establish this facility with Pricoa provides PFI with access to longer-term funding, which the company may use to finance investment opportunities, including upcoming brownfield opportunities. Moving over to for Slide 21. On this slide, the top graph shows our bank facilities and bonds that were in place as at 30 June, and the bottom graph illustrates our hedging profile. Interest rate hedging is providing us with an average of 65% of the company's debt hedged for an average rate of 2.49% for the remainder of the year, which gives us protection from -- some protection from rising interest rates. Turning now to Slide 23 on ESG. We continue to make great progress against our ESG strategic framework, which was developed in 2019. The slide picks out some of the highlights for the year-to-date. We're continuing to make great strides in replacing environmentally harmful R22 refrigerant gases, and we're proud to have recently committed to a 5-star green certification target for our upcoming development at 30 to 32 Bowden Road. We also have a busy program of ESG work for the remainder of 2022, including a refresh of our strategy. We've had our current strategy in place since 2019, and we've grown significantly in our team and capability in this space during that period, and it's now time to consider how the external environment has shifted in the past 3 years, fighting our focus and better reflect interaction with our business strategy, and we'll share the outcome of this work with you in due course. Moving to Slide 24. We're also changing how our facilities management services are delivered to allow us to play a more active role in the operational performance of our buildings. At present, we have an outsourced facilities management model where a third-party provides these services, meaning our team is somewhat removed from the day-to-day operation of the buildings. You see that by being closer to the operations of our buildings will be key to delivering on our environmental expectations both for the tenants and other stakeholders as well as positioning us to meet new regulatory requirements. We're in the early stages of bringing -- therefore, in the early stages of bringing facilities management in-house. The change is expected [indiscernible] material from a financials perspective, but we believe it will deliver a wider base for PFI. For example, we expect this change will position us to play a more active role in the energy and water efficiency of buildings, working with our tenants that want to improve the sustainability of the properties they occupy and ensuring that sustainable practices are embedded into our facilities management services. As I mentioned, we're still in the early stages of working through this opportunity, but we just wanted to keep you informed as we progress this. On Slide 25, on the governance front, we're pleased to announce the appointment of Carolyn Steele to the PFI Board and Audit and Risk Committee. Carolyn is currently the Chair of the Halberg Foundation, a Director of WEL Networks, Green Cross Health and Vulcan Steel. And she's also an investment committee member at Oriens Capital. She has a background in investment management, capital markets and M&A. It's great to have Carolyn on the team. We also know that Susan has advised us -- Susan Peterson has advised us that she will retire from the PFI Board in December this year, and Susan's presence will be missed by the Board and management team. So that's all for me for now. I'll hand you back to Simon, and I'll be around for questions at the end. Simon?

Thanks, Craig. Moving through to Slide 27. Yes. I'm just going to touch on the current market conditions. As you can see by the slide, Auckland industrial vacancy remains at historical lows, well below 1% for both prime and secondary stock. These favorable supply-demand conditions provide the platform for continued forecast rental growth. CBRE are now estimating annual growth of around 5% per annum over the next 5 years, and this forecast growth has the potential to offset any interest rate-driven softening in cap rates. At the PFI level, we've seen this dynamic playing out so far this year with our property values broadly flat in supporting our interim of $3.10 as at June 30. Looking forward, our portfolio of properties as well placed to capture additional rental growth, which, combined with the weight of capital continuing to seek quality industrial properties supporting the outlook for industrial property values. If we jump through to Slide 29. As many of you on the call today would know, when we look at our portfolio, split it into 4 categories or buckets. We do this as it gives us focus and enables us that with confidence as the portfolio continues to grow. As you can see, currently, all 4 buckets currently sit within the target ranges. However, an increasing area of focus for the team is the redevelopment of our existing holdings, the brownfield bucket, so to speak. So if you turn to slide 30, we've summarize that in a table. Approximately $220 million or 10% of our portfolio is held in such opportunities. These redevelopments allow us to invest our capital into accretive projects and key improvements, regenerating older assets that we own and the best in class buildings that weren't in the company's performance for the next 50 years and well beyond. So the next slide, Slide 32, you will see we have summary on 30 to 32 Bowden Road. That's located in Mount Wellington here in Auckland. The property is the final lease expiring in the first quarter of next year, and our plans for this 3.9 hectare site has been well advanced during the last 6 months. We've got the ability to develop up to 20,000 square meters of modern warehouse facilities. Construction will begin in April 2023 once existing tenant leaves the site. Pleasingly, we've secured a precommitment for around 40% of the site. We've entered into a 12-year lease with Tokyo Food who currently occupy a smaller warehouse around the road in Carbine road. Their relocation to our site allows them to consolidate several operations into what we consider a best-in-class property. We're targeting June 2024 completion date for their warehouse. And for the balance of the site, we're looking at building an 11,000 square meter facility on a speculative basis, noting that we've already received pretty good levels of inquiry for that building. Combined, the total project has an estimated spend of up to $75 million with a targeted yield on costs, including land in excess of 5%. The project will target a 5 Green Star rating. We're looking to create our first fully Green Star rated industrial state, which is pretty exciting. If you move through to Slide 34. It's Springs Road on the screen through to 34. During the process, we also made some good progress on our next brownfield opportunity or a large brownfield opportunity at 78 Springs Road. This is a large 10.4 hectare site in the heart of East Tamaki, presents us with the ability to develop or refurbish multiple warehouses ranging inside from 2,000 square meters up to 30,000 square meters. The existing lease with Fisher & Paykel appliances, who's our largest single tenant expires in October 2024. We anticipate all about investing about $150 million in a stage development over the medium term. Again, this project will target 5 Green Star ratings across all new buildings, which is exciting. If you move through to Slide 35. I just want to highlight the assets that we hold for sale. You can see we recently divested 2 smaller noncore assets in the regions and Shed 22, a Waterfront hospitality asset down at Wellington is currently being marketed for sale with offers due later in the week. These sales are part of our ongoing asset management program, where we're prepared to move noncore assets on. Obviously, we want to maximize value before we do. And then we use the capital recycle back into better opportunities as they arise. After these sales are complete, we expect the pro forma gearing to sit below 27%, which is a good place to be. Moving through the final slide of the presentation, just a quick review. To summarize, we're very pleased to deliver what we consider a very stable resilient set of results. Industrial property is an asset class that has continued to perform very well. Demand from occupiers remains very robust, supported by low levels of vacancy and projected rental growth. Pleasingly, our portfolio and strategy are benefiting from these dynamics. Looking forward, as always, there may be some challenges, but we believe that PFI is very well placed to respond to these. And just as importantly, we're ready to take advantage of the opportunities that will no doubt present themselves as we move forward. Thank you. That concludes the presentation. Craig and I are around, and here to take any questions you may have.

[Operator Instructions] Our first question comes from Nick Mar at Macquarie.

Just on the down the road side. Just talk to how you're thinking about, I guess, setting rents in terms of today's numbers versus June '24 numbers, given rents are expected to grow. And I guess, what you're willing to sort of give up in terms of risk return on that development between sort of leasing at the stick side now versus maybe in 12 months or so?

Yes. So good question, Nick. So it's fair to say for the development that we've committed to Tokyo Food, we have locked in an arranged number. Obviously, I can't give you that. But at a level there, we're pretty comfortable with giving up the initial piece of that site to be locked away. Going forward, it's something that we're seeing, in particular, hit the terms that we're very close to signing on 1 particular site. What we're doing is we've put in a number and then we're putting an inflator on that rental number. So you do get rental growth through that sort of 18-month development period, and that's to alleviate any cost increases that are forecast over the next 18 to 24 months. So you set the rent today and then you grow as you would a normal rent in your plethora of between 2% and 3%.

Yes. Sounds good. And in terms of the construction costs on that, have you locked much away, obviously early days, but in terms of getting confident on the construction cost.

Sorry, what we've done on the construction numbers there is with -- as is our usual, we've partnered up with a construction company very early on in the design phase. So effectively they give us a design -- sorry, a budget estimate, and we work through the next 6 months until we commit to the construction cost on value engineering that contract number. So we start with a number that's pretty robust, built up on the numbers from what they've seen in the market. And then as we complete the design piece and consenting piece, that number generally reduces. So yes, we're pretty conservative on how we start our forecast to where we end up. But we won't actually commit to the construction contract to just before construction begins.

Right. And then pretty good sort of leasing numbers coming through in terms of the spreads. How are tenants sort of feeling about those market reviews, obviously, market to market, but some pretty substantial increases for tenants?

Yes. It's something we monitor every month, obviously, as we collect rent. It's fair to say the tenants themselves, we're seeing very little evidence of stress on the rental side. Everyone we've talked to complaints about lack of labor. That seems to be the big sort of forecast issue at the moment. It's putting immediate coverage on that. But the rents themselves -- and some of these rent reviews, they haven't had one for 3 years. We're talking between 20% and 25% sometimes, and we're obviously going off and getting what our opinion of it is, and they're coming back. And generally, we're not arguing, they say 10%, we say 25%. We say 25%, they say 21%. So I think it's sort of an acceptance that at this point in the cycle, those rent numbers are just the rent numbers. And then you look at some of the new build rental levels that have been announced, particularly in the last sort of couple of months, up around 1 70 to 1 80. If you're going under the rent review that's taking someone from 115 to 135, 140, it still feels pretty good value. So at this stage, we haven't had too much pushback that's here to stay. We've had a really good run on the leasing side. As we mentioned for the second half of this year, pretty much every expiry is accounted for in some form or it's either being documented or agreed and being documented. So yes, at the moment, it's a bit of a hope and run really along that continue.

And then 1 last one for me, just on the USPP. Is there much you can sort of share on that? Is there a cost to have that stability established and sort of on the back bit until you need to use it and sort of any details on the terms when you do draw it down?

Yes. Craig speaking. So it's -- what's on at the shelf facility, so essentially, we've agreed all the documentation and signed all the documentation, and it gives us the ability to, I guess, very quickly draw against that facility if we'd like to. We pay a very small establishment fee, patrol the legals and all that sort of thing. But we don't pay any commitment fees or line fees or anything like that on an ongoing basis. And really, the rates are set by the sort of market conditions at the time. So we can draw down quite small amounts. We can draw in New Zealand dollars, which is quite effective from a cross currency point of view. So yes, I think it really works for us because one of the -- I guess, one of the big problems with USPP facilities is that you can -- you often have to go for quite large amounts. And so you often end up layering on quite a lot of cost by virtue of putting quite a lot of your book into that. So it felt like the way for us to put our toe into the water on this whole sort of thing. And with us developing brand new sort of longer-term assets through the brownfields pipeline, we're going to have a need for some longer-term debt over the next little while. So this gives us another option at this stage. So pretty low establishment costs to get another option in place.

[Operator Instructions] Our next question comes from Shane Solly at Harbor Asset.

Great to see you leading the charge in ESG again. Couple of quick questions, if I may. Interest costs over the next year, what are you thinking about, Craig? What have you got in the guidance?

Yes. I mean we take our swap book and then we put in a room book of, as we put together our numbers. So it's a 65% hedged plus, what is it, 3.5%, 4% rate on the sort of float stuff is what's in there at the moment, yes, which is moving around quite a bit, to be sure. So yes, that's the way we look at it. Does that answer your question?

Well, let's say a good start, so I'll build on that. So you are assuming rates continue to creep up in your guidance. Is that right?