Region Group (RGN) Earnings Call Transcript

Thank you for standing by, and welcome to the SCA Property Group SCP FY '22 Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Anthony Mellowes, CEO. Please go ahead, sir.

Thank you very much, and welcome to our FY '22 full year results for the SCA Property Group. My name is Anthony Mellowes, and I'm the Chief Executive Officer. Presenting these results with me today is Mark Fleming, our Chief Financial Officer. Our teams have been working extremely hard over these last 12 months, and I'm really pleased with the results that we've been able to achieve, particularly during the last 6 months where we have seen a real rebound. We have again remained true to our core strategy of investing in and managing convenience-based centers weighted to the nondiscretionary retail sector in Australia with a strong focus on everyday needs, particularly grocery, food and the medical categories. Firstly, let me take you to Slide 4, which sets out our FY '22 highlights. Our FFO per unit of $0.174 and our distribution per unit of $0.152 is an increase of 18% and 22.6%, respectively, on FY '21. Our net profit after tax was $487 million, an increase of over 5% on the same period last year, and our NTA increased to $2.81 per unit, an increase of 11.5%. Our portfolio occupancy is 98%, and our specialty vacancies staying steady at 5%. We made $347 million of acquisitions and divested $307 million in assets during the year, and our weighted average cost of debt is 2.5% with a 5.3-year weighted average debt maturity. Moving to Slide 5, which sets out some of the key achievements. With respect to optimizing the core business, our convenience-based centers performance is strengthening. Our comparable NOI growth was -- sorry, 3.3%, and our tenant sales are now 10% above pre-COVID levels. Our leasing spreads of 2% for the year, which included 3.3% in the second half. Our sustainability strategy is progressing well. All centers now have LED lighting, and our solar panels that we installed in Western Australia were all completed during FY '22. Our growth opportunities, our funds management. We wound up our SURF 3 in December 2021, achieving an IRR of 11% for all of our unitholders. And we entered into a joint venture with GIC for the SCA Metro Fund, and that was launched in April 2022, with a $284 million seed portfolio. We acquired 7 convenience-based centers for $347 million, and we divested 8 properties for $307 million, including 7 to the Metro Fund. On our capital management, our valuation like-for-like uplift of $354 million or 8.9% for FY '22. And our balance sheet remains in a strong position with gearing at 28%, which is below our targeted range of 30% to 40%. 81% of our debt is now fixed or hedged as of August '22. And our weighted average term to debt maturity is 5.3 years, and our cash and undrawn facilities of $453 million as at June. Finally, our funds from operations per unit of $0.174 increased by 17.9%, as I said, and the distribution of $0.152 increased by 22.6% over the same period last year. Now I'd like to hand over to Mark to present the financial results. Mark?

Thanks, Anthony, and good morning, everyone. I'll start on Slide 7, which shows the sales performance of our tenants and our cash collection rates during the COVID pandemic. On the top right-hand side of this slide, you can see that the sales performance of all categories of tenants has improved in the last 2 quarters of the financial year, following the end of lockdowns in New South Wales and Victoria, which is an encouraging sign as we look forward. Also, we note that total center sales are now 10% above pre-COVID levels, and that's also fairly consistent across all major tenant categories. In terms of cash collection, it's a similar story. You can see that cash collection rates were a bit weaker in the first half of the financial year during the lockdowns in New South Wales and Victoria, but again, rebounded strongly when lockdowns ended. We expect these trends to continue in the current half year period. Turning now to Slide 8, income statement. Our statutory net profit after tax was $487.1 million, which was up by 5.2% compared to the prior year. The results included a 19.9% increase in net operating income due to acquisitions and comparable NOI growth of 3.3%. Stepping down the P&L. The like-for-like fair value of investment properties increased by $354 million, primarily due to cap rate compression. Unrealized foreign exchange loss was due to a weaker Australian dollar, increasing the value of our U.S. dollar debt, transaction costs or costs associated with setting up our funds management joint venture with GIC. And finally, net interest expense decrease was due to one-off swap breakage costs in the prior financial year. Moving to Slide 9, funds from operations. To get to funds from operations, or FFO, we reverse out the noncash and one-off components of our net profit after tax, including fair value adjustments. FFO of $192.7 million was up by 21.2% on the prior year, primarily due to acquisitions and comparable NOI growth. AFFO of $169.5 million was up by 24.8% on the prior year, slightly more than FFO because of a decrease in leasing costs and fitout incentives, and AFFO per unit of $0.153 per unit was up by 21.3% on the prior year for the same reasons. Distributions were $0.152 per unit, representing a payout ratio of 99.8% of AFFO. Turning now to Slide 10, which shows our summary balance sheet. The book value of our investment properties has increased to $4.46 billion, due to $347.5 million of acquisitions and a $421 million increase in the value of investment properties. The valuation increase is primarily due to cap rates tightening by 47 basis points from 5.9% at June 2021 to 5.43% at June 2022. Net debt has increased due to the acquisitions completed during the period, offset by divestments. Net tangible assets per unit increased to $2.81 per unit due to the investment property fair value increase. Finally, our management expense ratio has reduced to 38 basis points due to the increase in assets under management. Moving to Slide 11, which deals with debt and capital management. As at 30 June, our gearing was 28.3%, 69% of our debt was fixed or hedged, and we had $452 million of cash and undrawn facilities. During the year, we issued $250 million of new 8-year medium-term notes at a fixed rate of 2.45%, and we used the proceeds to cancel an expiring bilateral facility. We now have no debt expiring until June 2024. Post year-end, we acquired 5 further properties for $180 million. We underwrote our August dividend reinvestment plan to 50%, and we amended an interest rate swap at 0 cost. As such, as at August 2022, our gearing has increased to 30.1%, and our fixed or hedged percentage has increased to 81%. Finally, as you can see, we are well within our banking covenants. Thank you, and I'll now hand back to Anthony for the operational performance overview.

Thank you, Mark. Now turning to Slide 13. Just a quick overview of our portfolio. As of the 30th of June, we had 77 neighborhood, 1 freestanding Woolworths and Big W at Katoomba and 13 convenient subregional assets comprising approximately 770,000 square meters with over 2,000 specialty tenants. Our weighted average cap rate is 5.4%. And as you can see, our geographic diversification is well balanced across all states and territories in Australia except for the ACT. 47% of our gross rent continues to come from our anchor tenants, including Woolworths, Coles, Wesfarmers and ALDI. Of the other 53%, there is a heavy weighting towards our core nondiscretionary categories being food, retail services and pharmacy and medical. Slide 14 describes our portfolio occupancy. Specialty vacancy is stable despite continued COVID-19 challenges during the year. Our occupancy level increased slightly to 98.1%, and our specialty vacancies remains at 5%, which is at the top end of our target range of 3% to 5%. Our specialty tenant monthly holdover is 4.3%, up from 3.9% at December 2021. Turning to Slide 15. Our sales growth and turnover rent is increasing due to strong supermarket sales. Our total supermarket MAT growth for FY '22 compared to FY '21 was 2.4% although panic buying from FY '21 has not been repeated and there were lockdowns in New South Wales and Victoria during the first half. The sales growth has accelerated in the fourth quarter of FY '22 with 4.5% growth compared to the same quarter in FY '21. Compared to pre-COVID, total MAT has increased by in excess of 10%, with all categories recording strong growth, and turnover rent has increased to $5.5 million with 47 anchor tenants paying turnover rent as at the 30th of June, and 45% of supermarket anchors now pay turnover rent. There is another 14 anchors that are within 10% of their turnover thresholds. And there were 2 anchor tenant turnover rents captured in a base rent review during the year. Our specialty key metrics for our existing centers are outlined on Slide 16, and we saw a strong [ second ] half. The strong second half leasing performance with positive spreads in our second half of 3.3% versus the first half were basically flat. And we've had fairly stable sales growth and reducing occupancy cost positions as well for future rental growth. Our sales productivity at $9,865 was slightly down from June 2021 of $9,954. Our average rent per square meter remains unchanged at just under $800 a square meter, and our occupancy cost increased slightly from 8.6% to 8.7%. Our annual fixed rent reviews of 3.9% are applied across 88% of our specialty tenants. Turning to Slide 17. This outlines our sustainability strategy. We are targeting 6 key areas where we can have maximum impact. And the key highlights for FY '24 -- FY '22 are our energy and carbon. We've spent approximately $18 million on installing solar panels in all of our Western Australian centers, also depleting R22 gasses, and we are now 100% LED across all of our centers. We've completed a portfolio-wide climate exposure analysis on climate risk. We have maintained our 40:40:20 gender balance. Our energy rating, we achieved a 6-star NABERS rating for our corporate head office. And we also sponsored 128 children through our partnership with The Smith Family. The key focus areas for FY '23 will again be energy and carbon, carbon risk and also aligning to the principles of the TCFD as that comes in over the next 12 to 18 months. Mark, would you like to discuss funds management?

Sure. Thanks, Anthony. I'm now on Slide 19. Earlier in the year, we wound up the last of our SURF retail funds. All 3 of those funds were successfully concluded with internal rates of return in excess of the 10% hurdle. And as such, we received performance fees for each of those funds. In April this year, we successfully launched the SCA Metro Fund, which is a joint venture with GIC of Singapore. GIC owns 80% of the fund and SCA owns 20%. SCA is the property manager and the investment manager. The fund was seeded with a portfolio of 7 assets from SCA for $284.5 million. And in July, the fund acquired a neighborhood center in Beecroft, Sydney for $65 million, bringing the total funds under management to around $350 million. The initial target fund size is $750 million. This fund will focus on neighborhood centers in metropolitan locations with a particular focus on Sydney and Melbourne. Anthony, back to you.

Thanks, Mark. So in growth, opportunities continue to look at acquisitions. And FY '22 was again an active year for us. We completed 7 centers. And we also contracted a further 5 centers in June. And we also have acquired some adjoining land and a childcare center at Marian in Queensland. So again, another busy year for us. Slide 21 just highlights the, again, the fragmented ownership in our sector, which provides us with great future acquisition opportunities. We are now the largest owner by number of neighborhood centers, and we'll continue to consolidate by utilizing our funding and management capability to execute on these acquisition opportunities. Since listing, nearly 10 years ago, we have now acquired 64 convenience centers for over $2.5 billion in aggregate. And the majority of these acquisitions have continued to be off market, and we expect this to continue. We've also divested 42 freestanding and neighborhood centers for over $800 million. There was continued demand from investors for these neighborhood centers during the year, and we will continue to be disciplined with respect to acquisitions. We believe we're well positioned to take advantage of any change in the market as a result of movement in interest rates. On Slide 22, our indicative development pipeline is highlighted for the next 5 years, and we've identified and are working on over 30 potential developments with CapEx spend in excess of $300 million. And again, a continued focus on sustainability going forward. And we also have in there our Lismore rebuild, which is going to occur in FY '23, which is mostly covered by insurance. I'd now like to talk about our key priorities and outlook. On Slide 24. Our core strategy remains unchanged. We'll continue to seek and deliver defensive, resilient cash flows to support our growing secure distributions. We'll continue to focus on the convenience-based retail centers with strong weighting in the nondiscretionary retail segment. Again, we'll be seeking long-term leases to quality anchor tenants such as Woolworths and Wesfarmers, and again demonstrated by our latest acquisitions. And we'll continue to explore both the core business growth opportunities in our development pipeline, acquisition opportunities and also fund management opportunities. Mark, can you discuss our longer-term AFFO growth targets?

Thanks, Anthony. Slide 25 sets out our medium- to long-term target, which is to grow AFFO per unit by 2% to 4% per annum. This earnings growth will come from a combination of comparable NOI growth, supported by supermarket turnover rent and specialty rental increases, developments, acquisitions and funds management underpinned by disciplined control of our operating expenses and capital expenditure. In FY '23, we currently expect that our AFFO per unit growth will be below the bottom end of the target 2% to 4% range due to a sharp increase in interest rates, but we expect to return to this range once interest rates stabilize. Moving on to Slide 26, which explains our FY '23 AFFO per unit guidance in more detail. As you can see, in FY '22, we grew net operating income strongly, primarily due to acquisitions and comparable NOI growth of 3.3%. In FY '23, the divestment of the 7 assets to the GIC Metro Fund reduces the net contribution from acquisitions and disposals, and our guidance assumes that we won't complete any further acquisitions either on balance sheet or in the Metro Fund this financial year. We are, however, expecting strong growth in comparable NOI for 2 reasons. Firstly, we believe that inflation will increase the turnover rent from our major tenants. And secondly, we believe that we can achieve an uplift in specialty and Mini Majors income from a combination of positive leasing spreads and reduced vacancy as we rebound from COVID. The obvious detractor from our FY '23 earnings growth is interest expense. We're expecting that our weighted average cost of debt will increase from 2.5% to 3.4%. And this assumes that the weighted average 3-month bank bill swap rate during FY '23 will be 3%, in line with the current market curve. If we excluded the impact of increased interest rates, our FY '23 guidance would actually have increased by 6% versus FY '22. Moving to Slide 27, which gives a sensitivity for the FY '23 guidance around different interest rate outcomes. As you can see from the bottom left chart, in FY '23, every 50 basis point change in the average bank bill swap rate changes AFFO per unit by around $1.7 million or 0.15 cents per unit. I know some investors and analysts will have their own view around interest rates over the next 12 months, and this should assist them in forming their own forecasts. Anthony, back to you for closing comments.

Great. Thanks, Mark. So just finishing on Slide 28, our key priorities and outlook. We are looking to generate strong sustainable comp NOI growth and continue to pursue these growth initiatives in a really disciplined way. With our core business, our focus continues to be to serve our local communities for their everyday needs, partnering with our supermarket anchors to improve their online offer and actively managing our centers to ensure that we have successful specialty tenants paying appropriate rentals, and we'll continue to execute on our sustainability initiatives. With respect to our growth opportunities, we're going to continue to explore the value and earnings accretive acquisition and divestment opportunities that are consistent with our strategy, and we'll progress our identified development opportunities, including our sustainability investments. And finally, we are really looking to continue to grow the SCA Metro fund. With respect to capital management, we'll continue to actively manage our balance sheet to maintain diversified funding sources with long weighted average debt expiries and a lower cost of capital consistent with our risk profile. And we're going to actively manage the interest rate risk in the current volatile market. Now gearing will remain below 35% at this point in the cycle. And our FY '23 FFO guidance is $0.17 per unit and AFFO is $0.15 per unit. As Mark said, this guidance assumes no further acquisitions, either on balance sheet or in the SCA Metro Fund, and the weighted average 3-month BBSW for FY '23 will be 3%. In conclusion, I'd like to say that during these volatile times, we'll continue to deliver on our clearly stated strategy and objectives. We're going to continue to focus on and optimize our core business, with a particular focus on rent collection and continued deal flow on renewals and vacancy. We've built solid foundations to enable us to continue to seek out and execute on the growth opportunities that are consistent with our strategy and risk profile. FY '22 was another challenging year for our team. However, the strong rebound experienced in the second half of FY '22 reinforces our strategy, and we see no real reason to deviate from it. Now I'd like to invite any questions.

[Operator Instructions] Your first question comes from Caleb Wheatley with Macquarie Group.

My first question was just following up on your comments around leasing spreads moving forward. Obviously, pretty good outcome over this half at 3.3%, especially with sales still 10% ahead of pre-COVID levels. How should we be thinking about those leasing spreads going forward? I'm conscious you've got that 2% to 4% range that you sort of target. Are you expecting to continue to, I guess, improve at least in the near term while sales are so far ahead of pre-COVID levels?

Yes. Thanks, Caleb. Mark. I'll have a crack at that. The answer is yes. So second half, 3.3% leasing spreads. In FY '23, we're expecting at least that number. And there's a -- the main reason for that is that we are coming out of COVID. And as you know, during the COVID period, we weren't able to get the sort of renewal spreads that we had in the past. It's been pretty flat or slightly negative. But now that we're coming out and that the sales momentum of the tenants is very strong, fourth quarter sales growth of 4.4%, for example, we think we can take advantage of the fact that our specialties are, in our view, under rented. So our rent per square meter on specialties is only $793 per square meter. That's the lowest in the sector. Our occupancy cost is 8.7%. That's the lowest in the sector. So we think that we can continue to get those positive leasing spreads and bring those rents more up to a market type of level.

Yes. I've just been thinking about those spreads on a, I guess, a medium-term view. Is there any sort of concerns around potentially a normalization or an unwinding of the shop local trend? Or it sounds like maybe that hasn't been a real tailwind anyway and there's not a huge amount of unwind? How should we think about the sort of medium term there?

No, I don't. It's Anthony here. I don't think so. I think the shop local trend is here to stay. I don't know about your office, but our office is basically 3 to 4 days a week. And I think we're at the upper end of where most offices are. So -- but that's for CBD in Sydney. Other areas, it's different. But I just think there is a lot more working from home and flexibility that's coming to life generally, and I think that's a permanent change.

Great. And just a final one for me. You mentioned very briefly in the presentation. Can you give a little bit more color just in terms of how you're seeing opportunities for acquisitions, both within, I guess, the mandate of the SCA Metro Fund and the more sort of core SCP balance sheet type opportunities? Are you seeing more of those given recent interest rate rises?

Yes, that's a really good question. And I think we're going to get asked this a lot over the next couple of weeks. Look, leading up to in May, there was a fair bit of activity. There was a bit of product out on the market, a few things closed out. There hasn't been much closed out during sort of June, certainly in July. There is now a lot of stock on the market. There's a number of portfolios on the market. I think there is still a lot of private interest. I think the larger dollar values, which becomes more institutional, people are sort of sitting back and looking, "I'm wondering when the volatility of interest rates is going to settle down." We haven't seen in the last 6 months, many things -- many transactions actually closed out. I think there's probably a gap between vendor expectations and purchaser expectations as we sit at the moment. And I think over the next 4 to 5 months, we'll see how that plays out. I will say that in our sector, pre-GFC, during the GFC, post GFC, leading up to this, there's always been about 40 transactions per annum. And I think the same will happen this year, although it could be a bit slower in this first half as that gap equalizes. But I think there is a gap there between vendors and purchasers at the moment.

Yes. So Caleb, just on the guidance, as I said, we have not included any acquisitions either on balance sheet or in the Metro Fund. Potentially that's conservative, but on the other hand, that's the way we always do our guidance. That's the way we've always done it in the past as well.

But there's a lot of product out there. And buying is easy. You can just pay $1 more than the next person. But it's buying at value is the important thing.

Yes. In terms of that spread that you're referring to between buyers and sellers, is there sort of a high level rule of thumb that you've seen that spread open up to?

No, I haven't seen it yet. I know from our perspective, we're probably sitting there thinking there's 25, 50 basis points difference now than where we were 3, 4 months ago. That's our view, but the market could be different.

Your next question comes from Solomon Zhang with JPMorgan.

First question for me was on the corporate cost just on Slide 8. So the full year impact was $18.7 million, but the first half was $9.8 million. So it implies that corporate costs have declined about $1 million half-on-half. Anything you call out there in terms of seasonal items? Is this sort of a rebasing lower post COVID, just noting that corporate cost has been about $10 million for the past 2 halves?

Yes. Look, we do tend to have a little bit of seasonality sometimes between first half, second half. In particular, we pay the bonuses in the first half of the financial year. So that's probably the main explanation for that. So probably not -- I wouldn't look half-on-half. I'd look at the whole -- the total year number as the sort of ongoing run rate.

All right. Second question was just around the COVID impact, just on Slide 7. It seems that net impact for the full year was just $0.1 million, given the waivers, offset by the release in the provision. So I just want to confirm my understanding, yes, is that a $2 million positive impact to FFO in the second half then?

Yes. So in the second half, we -- most of that impact was in the first half, as you say. So net-net for the year, you're right, it's a $0.1 million negative, very limited impact in the second half. But I guess with the ECL, the thing behind that is it's not just unwinding a balance sheet provision. It's actually reflective of cash collection rates. And looking forward, we've still got an $8 million ECL provision. If we can continue to collect at 100% or above, then that's what will help drive that ECL number. And we're hoping, obviously, that in FY '23, we'll be able to continue with that momentum of cash collection and therefore, be able to release more of that provision.

Right. Maybe just a follow-up. Is there any guidance, any additional ECL provisioning in guidance at the moment? Or is that $8 million going to be sufficient in your view?

Look, I think the $8 million is sufficient, but there could be some upside if we can collect more than we expect.

Our next question comes from Sholto Maconochie with Jefferies.

Just a couple on the turnover. And if I look at the previous -- in 1 half '22, you had 45 anchors paying turnover, and now you've got 47, which is 45% of anchors. What was that percentage of supermarkets before in 1 half?

Well, we had...

Yes.

Yes, Sorry. Go ahead.

No, no. You go.

Yes. The -- I actually haven't got the percentage in the previous, but 42 anchors has gone up to 47, so obviously, an increase of 5. I'd have to go back and calculate what that percentage is in FY '21, sorry.

Because if you look at the -- 2 anchors were paying turnover rent were captured in base. And then there was still 2 at the first half, but there was 16. So those -- there was no increase between the first and second half on the anchors that were captured in the base rent?

So sold some assets that could have been in turnover rent as well. So yes, we'd have to come back to you...

We'd have to come back to you on the reconciliation of that.

Yes, okay, probably not [ like-for-like ]. And then just I'll stick to that theme. What sort of -- over the next sort of 3 years, given the high food and supermarket inflation, what do you think that will benefit? Because the turnover has been increasing quite materially over the last few years. Is that -- should go into base rent and be a -- should be at the sort of top end of that sort of your guidance sort of bridge where you talk about the like-for-like, that 2% to 4% going -- driving that indicative growth of the 1% to 3% comp NOI?

Yes. So the way -- the way I think about the anchor turnover rent is as follows. So let's assume that we're going to -- and I'm just not saying these are our forecast, but just for argument's sake, that there's 4% growth in supermarket sales in FY '23. And that 45% of our supermarkets are paying turnover rent. That means if the 4% was evenly spread across all supermarkets, that would mean that the anchor tenant line, the anchor rental line would grow somewhere between 1.5% and 2% and probably closer to 2%, given that 45% of our anchors are in turnover rent -- our supermarket anchors. So when I think about that long-term guidance, I'd say, look, call it -- and obviously, we're in an inflationary environment now. So we are expecting good strong supermarket sales. So if we can get 2% growth from our anchor rents and we can get, call it, 4% growth from our specialty rents, then we should be able to grow comp NOI at 3% or thereabouts, which is the top end of our target range. And that's really what we're looking for in FY '23 is to grow at that top -- that higher end, the 3% level or better because of that combination of supermarket inflation driving turnover rent and the under-renting of the specialties and the spreads -- the positive spreads we're expecting to get, as I discussed earlier. The other thing with the specialties to recall is that they generally have 4% fixed step-ups in the leases. So they grow by 4% for 4 years, and then the spread is obviously on the fifth year.

Yes. And then just -- you've only got about 3 ALDIs in the portfolio. The -- from my understanding, [ they've just gone up at ] CPI. So is the plan to just put some more [ NGS ] centers given the -- this is a market that will be quite advantageous to the portfolio?