Region Group (RGN) Earnings Call Transcript

Thanks very much, and welcome to the first half FY '23 financial results for Region Group. My name is Anthony Mellowes. I'm the Chief Executive Officer. Presenting these results with me today is Evan Walsh, our Chief Financial Officer; and Mark Fleming, our Chief Operating Officer. Also, in the room with me is Campbell Aitken, our Chief Investment Officer; and Erica Rees, our Company Secretary and General Counsel. I'm pleased with this set of results as it reaffirms that we continue to remain true to our core strategy of investing in and managing convenience-based shopping centers weighted to the nondiscretionary retail sector. Firstly, let me take you to Slide 4, which sets out our first half highlights. Our statutory net loss after tax of $95 million, our FFO per unit of $8.35, down slightly over the same period last year. Distribution of $7.50 per unit is up 4% on the same period last year. And our gearing was 31.7% as at 31 December 2022. Our NTA has decreased to $2.65 per unit, down by 5.7% against 30 June 2022, and our portfolio weighted average cap rate is now 5.67%. Our weighted average cost of debt is 3.2%, and our portfolio occupancy is 98% with our specialty vacancy sitting on 4.9%. We acquired $180 million of assets and divested to $23.5 million of noncore assets during the first 6 months to December 2022. Moving to Slide 5. We've got solid leasing and sales results is driving the performance of our core business. With respect to optimizing the core business, our comp NOI growth was 4.2%. We had good leasing spreads of 4.4% for the period with an 86% retention rate. Our specialty vacancy rate improved to 4.9%, and we maintained that portfolio occupancy at 98%. Our tenant sales increased by 3.6% with nondiscretionary sales growth of 6.4%. We're progressing well towards our Net Zero by FY '30. All of our shopping centers have LED lighting and smart digital energy meters installed. And currently, there are 12 solar sites that have been installed with 8 sites under construction and a further 12 sites in design. With respect to growth opportunities. Our assets under management has grown from $1.3 billion since listing in 2012 and now exceeds $5 billion. As I mentioned earlier, we did acquire 5 convenience-based shopping centers for $180 million in July 2022. With respect to funds management that our Metro Fund did acquire Beecroft Place in July 2022 for $65 million. With respect to divestments, we divested Carrara Shopping Center, which was contracted for sale in November 2022 for $23.5 million, a 2% premium above our June book value. And we also, during January 2023, sold our remaining securities in CQR, realizing net proceeds of nearly $27 million. With respect to capital management, our balance sheet is in a strong and robust position. At December, we had cash and undrawn facilities of $278 million. We have hedged and fixed debt of 76.5%. Gearing was 31.7%, which is at the lower end of our range. And we have no debt expiries until June 2024. However, post the sale of CQR units, the Carrara Shopping Center and the proceeds of the January 2023 DRP, our pro forma metrics changed to having cash and undrawn facilities of approximately $370 million hedged in debt and fixed debt increases to approximately 82% and our gearing decreases to under 30%. I'd now like to hand over to Evan to present the financial results.

Thanks, Anthony, and good morning, everyone. I'll start on Slide 7, which shows our financial results for the half. Our statutory net loss after tax is $95.1 million, which is down 122%. And this has largely been driven by $148 million decrease in the valuation of our investment properties. Now backing out the noncash and nonoperating items, the underlying performance of our business remains resilient with funds from operations down just 0.2% to $94.1 million. Our adjusted funds from operations which -- where we deduct the spend on maintenance capital and leasing incentives has grown by 5.9% to $85.7 million. Our AFFO per security has increased by 3.4% to $7.6, with the distribution being $7.5 per security being $0.03 higher than the first half of FY '22. The FY -- distribution represents a payout ratio of 99%, which is in line with our target. Increased market interest rates has seen our net interest expense increased by approximately $6 million with our cost of debt increasing from 2.4% to 3.2%. The increase in these interest rates is partially mitigated through 76% of our debt being hedged or fixed. Excluding the impact of this increased interest expense, our FFO has actually seen a robust increase of 5.3% with AFFO increasing by over 11%. Net property income has increased by a solid 4.2% for the half, with comparable NOI increasing by 4.2% or $4.4 million. This has been driven by strong leasing outcomes, increasing turnover rent and a reduction in our specialty vacancy rates. We received a total of $11 million of insurance proceeds primarily related to the flood damage at Lismore Central. $1.8 million of this has been allocated as income, which relates to loss rent and additional operating expenses incurred through supporting the redevelopment. The Metro Fund acquisition of Beecroft Place has increased assets under management by $160 million, driving a 25% increase in funds management income. Corporate expenses remain controlled with costs slightly lower than previous period, and we expect that maintenance and leasing expenditure to be weighted to the second half of FY '23. Turning to the next slide, which shows our summary balance sheet. As Anthony mentioned, our assets under management have increased to over $5 billion, which is a 1.7% increase over 30 June with $245 million of acquisitions over the half, including the Metro Funds acquisition of Beecroft Place. As Anthony also mentioned earlier, Carrara Shopping Center was contracted for sale in November 2022. And that's held as an investment property for sale at $23.5 million, and we sold our remaining -- our holding in inside our retail rate. No COVID-related rental assistance was provided to tenants in the half, and we have had a strong cash collection rate. As a result, we have seen a reduction in our expected credit allowance by $1 million. Our securities on issues have increased by 1.5% mainly due to the underwriting of 50% of the June 2022 distribution. Now on Slide 9, which highlights our property valuations. Our total property portfolio value has increased by $26 million to $4.487 billion. During the half, all centers were internally valued with -- in addition to 20 centers being selected to be independently valued. This has resulted in a like-for-like decrease of $131 million. We have seen a 23 basis point softening of market capitalization rates to 5.67% with our neighborhood portfolio at 5.5% and our sub-regionals at 6.12%. The reduced valuations were offset by the acquisition of the $180 million portfolio in July and approximately $11 million of capital expenditure spend and the impact of accounting adjustments. The decrease in property values saw our net tangible assets reduced by 5.7% to $2.65 per security. Moving to the next slide. We maintain a prudent approach to our debt and capital management given the uncertain market conditions with our available cash and undrawn facilities being around $277 million at 31 December. Gearing was sitting at the lower end of our target range of 30% to 40% at 31.7%. Post period end, we have collected a total of $69 million from the sale of our CQR Holding and the underwriting of 50% of our December distribution. With the expected proceeds from the settlement of Carrara Shopping Center, our pro forma available cash and undrawn facilities increases by approximately $93 million to $370 million, with our pro forma gearing reducing to under 30%, which is below our target range. At 31 December, our fixed and hedged debt increased to 76.5% with an amendment to an existing interest rate swap, increasing our hedging by $100 million. On a pro forma basis, our hedging -- hedge debt increases to 80% of our total net debt. The forecasted FY '23 weighted average cost of debt is 3.4%, which is up 0.9% versus FY '22 and follows a forecast in 2.9% increase in market interest rates over the same period. Although the reduction in property values and the increased interest rates impact our gearing and interest cover ratios, we remain well within our debt covenant requirements. We have stress tested these metrics with every 25 basis points movement in capitalization rates. This would see a change in property valuations, resulting in a 1.5% movement in gearing. And for every 25% movement in market interest rates, interest expense would change by approximately $400,000. Moving to Slide 11. We show some key charts highlighting the strength of our debt and capital management position. We continue to take a balanced approach to debt and capital management with our strategy aimed at minimizing risk, targeting attractive rates for our debt facilities whilst providing flexibility for future growth opportunities. We have a diversified debt book of $1.5 billion with approximate [indiscernible] split across bank provided debt, medium-term notes and U.S. private placements. 82% of this debt is expected to be hedged at the end of FY '23. In FY '24, we remain well protected against adverse increases in interest rates with 71% of debt expected to be hedged. We have no debt expiries until June 2024, with negotiations being well progressed for the extension of our bank debt expiring in both FY '24 and FY '25. The $225 million medium-term note expiring in FY '24 is covered by available cash and undrawn debt facilities. I will now hand over to Mark, who will take you through our operational performance.

Thanks, Evan. I'll start on Slide 13 that gives an overview of our portfolio. As at 31 December, we had 13 convenience-based subregional assets, and 82 neighborhood assets. Our assets have a gross lettable area of approximately 798,000 square meters, and we own over 2.5 million square meters of land. 46% of our gross rent comes from our anchor tenants, including Woolworths, Coles and Wesfarmers. And of the other 54%, there is a heavy weighting towards our core nondiscretionary categories being food and liquor, retail services and pharmacy and health care. Finally, as you can see, our geographic diversification is well balanced across all states in Australia. Slide 14 shows our portfolio occupancy. Our occupancy level is stable at around 98%. The long-term stability of our portfolio occupancy illustrates the resilience of the portfolio. Specialty vacancy decreased slightly to 4.9%, which is still towards the top end of our target range of 3% to 5%. Specialty tenants on monthly holdover reduced slightly to 3.9%. Turning now to Slide 15. Tenant sales growth has been robust with moving annual turnover growth of 3.6%. Specialty tenant sales growth of 5.8% was particularly pleasing as they continue to recover from the COVID period. Our tenant sales are now approximately 12% above pre-COVID levels. Our turnover rent is also increasing due to continuing growth in supermarket sales. 51 anchor tenants are now paying turnover rent, which represents 39% of total anchor tenants and another 15 anchors are within 10% of their turnover thresholds. Two anchor tenant turnover rents were captured in a base rent review during the year. Moving now to Slide 16, supermarket online sales. We continue to support the online offering of our supermarket tenants. Online sales are included in 96% of our supermarket turnover rent calculations, so we benefit from increased turnover rent as online sales grow. Our research indicates that having a convenient online supermarket offer also increases foot traffic and in-store sales for our specialty tenants. Our centers are ideally located for last mile logistics, and we believe that the store-based fulfillment model will remain the predominant model for online grocery fulfillment. Turning now to Slide 17, specialty key metrics. We had a strong leasing performance during the half year with 198 deals completed at an average positive leasing spread of 4.4%. Ongoing sales growth and relatively low rents positions us well for future rental growth. The sales productivity of our specialty tenants has increased to over $10,000 per square meter, while our average rent per square meter remains at around $800 per square meter. As a result, despite the strong positive leasing spreads during the half, our specialty occupancy cost remains relatively low at 8.7%. Our specialty leases are generally 5-year leases and most of them have annual fixed rent reviews of around 4% per annum. Slide 18 provides a sustainability strategy update. Most pleasingly, we're on track to achieve our Net Zero target by 2030 or before. We've completed our LED rollout and have now installed 9 megawatts of solar panels on our roofs, well on the way to our target of 25 megawatts by FY '26. We're also gradually replacing R22 gas at our centers, installing building management systems and exploring opportunities for on-site battery storage. Other sustainability targets are also progressing as planned. We're in the process of completing climate risk assessments at 6 of our centers during FY '23 on top of the 6 we completed in FY '22. And we continue to focus on improving our engagement with our local communities including via our partnership with The Smith Family and the development and implementation of local community engagement plans. Thank you, and I'll now hand back to Anthony.

Thanks, Mark. Carry on to Slide 20, which is about our acquisitions and divestments. As you can see there, we acquired 5 centers, predominantly in Derna Court and Fairview Green in Adelaide, Delacombe, Brassall, Port Village and Tyne Square, a couple in Queensland [indiscernible]. Now we also contracted to sell Carrara in Queensland, which I mentioned before, above our June book value. And recently, we just sold our remaining investment in CQR. We'll continue to remain disciplined with respect to acquisitions while we're always being opportunistic with respect to asset sales. With respect to the market, the convenience-based shopping center market, although the market did definitely slow in the 6 months to December '22, we believe that we're really well placed with our gearing below 30% to continue to source some acquisitions that will be earnings-accretive and also add value to our portfolio. Turning to Slide 22, Funds Management. Our joint venture with GIC really does offer us a good platform for growth. It did commence in FY '22 with 7 seed assets, and we did acquire Beecroft in July for $65 million. It is a fund that is all about metropolitan neighborhood centers, and it has an initial target fund size of $750 million. The ownership is 80% GIC and 20% Region Group. This really does position us well to access those metropolitan neighborhood in partnership with a high-quality globally recognized partner while also growing some more asset-light management fee income. Slide 23 outlines our indicative development pipeline. We have in excess of $250 million of investment over the next 5 years, predominantly in 2 areas being the traditional developments of the shopping centers, but also our key sustainability initiatives that Mark was talking about predominantly in the larger solar areas. Now I'd like to talk about our key priorities and outlook on Slide 25. Our core strategy remains unchanged. We will continue to seek and deliver defensive, resilient cash flows to support secure and growing long-term distributions to our security holders. We will continue to focus on convenience-based retail centers with that strong weighting to the nondiscretionary retail segment. We'll be seeking those long-term leases to quality anchor tenants such as Woolworths, Coles, [indiscernible] and the Wesfarmers Group, which was again demonstrated by our latest acquisition. And we'll continue, as I said before, to explore core business growth opportunities, but remain disciplined with respect to acquisition and disposal opportunities that meet our investment criteria. Evan, do you just want to run through Slide 26, our longer-term AFFO growth target?

Thanks, Anthony. Slide 26 has been a pretty consistent slide for us over the past few periods. This highlights our longer-term target to grow our adjusted funds from operation by 2% to 4%. We target comparable NOI growth of 1% to 3%, which is supported through an expected sales growth for anchors of 2% to 4% per annum. And we should see this increase the number of anchor tenants paying turnover rent. 55% of rent is derived from our specialty tenants, where around 90% of our tenants are consistently paying average fixed growth rate of 3.9%. For tenants that expire, we expect rents to grow by at least 2% over the prior rent. Growth opportunities are indicated to add at least 1% to our target growth with a focus on investing in value-added extensions and refurbishments, selective acquisitions and through growing our funds management business. Corporate expenses are targeted to increase by no more than the NOI growth rate and the impact of interest expense is to remain neutral to our longer-term growth targets. However, we expect there to be a short-term impact from current market pricing. Capital expenditure is expected to remain as a constant percentage of our property values. Back to you, Anthony.

Thanks, Evan. So finally, really on to Slide 27. We will continue to drive that strong and sustainable NOI growth while maintaining our gearing at the lower end of our target range. With respect to that core business, we're going to generate that sustainable NOI growth by driving increased rental income from our specialty and mini major tenants, partnering with our anchor tenants to drive turnover rent and leveraging our scale to maintain controllable property expenses as a percentage of property income over time. We'll be continuing on our path towards Net Zero by FY '30. With respect to growth opportunities, as I said, we're going to remain disciplined with earnings-accretive acquisitions and divestment opportunities, targeted spend on the development pipeline and sustainability investments and continuing to expand our funds management platform through the Metro Fund. With respect to capital management, we're going to maintain that appropriate capital management strategy, which includes gearing at the lower end of our range of 30% to 40%, although at the moment, we are below that, and our interest rate hedging to remain at the higher end of our target range of 50% to 100%. We're actively managing our upcoming debt expiries and maintaining sufficient capacity to fund any identified growth opportunities, and we expect the DRP to remain in place. Our FY '23 AFFO per unit guidance is upgraded to achieve at least $0.152 per unit, but that assumes no further acquisitions or disposals and that the 3-month BBSW for the second half of FY '23 is 3.6%. I'd now like to invite any questions.

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

First question is just around guidance. So slight upgrades there on AFFO to $0.152 per share. We've got some divestments, albeit coming through in the second half. Just wondering what drove the upgrades to expectations as we go through second half of '23?

So there's 2 main reasons for the upgrade. One is the impact -- the full year impact of the acquisitions we did back in July. And the second one is the underlying performance of the comparable NOI growth with some of the leasing outcomes driving the first half flowing through to the second half.

Okay. So a bit of outperformance in the like-for-like NPI. I would have thought the impact of acquisitions is largely known when guidance was provided in August. Has there been some outperformance or some additional accretion has come out of that than what was originally anticipated?

It was slightly better, but not dramatically better. The major area was out, as Evan said, was just -- we had bits and pieces across the area -- across all the areas, some turnover rent, specialty rent, et cetera, did slightly better. And that was also offset by sort of slightly higher interest as well. And a slight better forecast on where we're heading with capital for leasing and maintenance capital this year.

[indiscernible] where we were in August, apologies on that maintenance CapEx turned. I know you flagged the second half skew but how should we think about that going into the second half?

Sorry, just cut out, was it the CapEx in the second half?

Yes, just exactly how that skew is going to play out [indiscernible].

Look, I think based on current -- I think the last couple of halves have sort of been a bit lumpy up and down. So we are expecting the spend to be slightly higher in the second half and fits within our guidance of $0.152.

Second one is just around the FFO guidance. So you provided it was expecting $0.17 per share in August. Doesn't look like there's been any additional update there, provide some color as to maybe what you're expecting FFO and if there's no additional color, just the rationale behind that?

So the FFO guidance remains in line with 6 months ago at $0.17. And it's really driven by the increased interest expense, and that's offset by the underlying NOI performance.

Great. Second one for me is just on the GIC joint venture. So it looks like the gross asset in the fund has increased in the FY '22 update. Just wondering if you could provide some additional color on what you're seeing in total opportunities for those more metropolitan-located assets, and how your partners see that or how we should think about growing that fund moving forward?

Yes. No, that's a good question. Look, the whole acquisition market has slowed considerably in the last 6 months as interest rates rose. There was a big gap, as I spoke about in our August results emerging between vendors expectations and purchases expectations and hence, not a lot of deals were done. So us as a purchaser, and I'll put our partner, GIC in that, with interest rates increasing, cost of capital increasing, you needed to get a better return out of that particular asset or out of any asset that you're looking at, and that's where this vendor expectation on price and the purchase expectation price were different. Now that gap has closed, and we have seen a couple of acquisitions this year already that were being negotiated in the last part of last year. I think there's still a bit of a gap there. And our joint venture partners have a similar view that until the market reaches or that gap is closed that will probably be remaining very disciplined because it's got to be accretive to buy. And if you can't buy an accretive amount, you're going to make sure there's going to be very strong growth in that asset. So that's where we're sitting at the moment. I think our joint venture partner with their particular views of this investment has similar views.

So just waiting for that pricing to come through and being a bit more prudent with capital, but it sounds like we should expect that to recover. Thank you very much. Appreciate your time this morning.

Next question comes from Sholto Maconochie with Jefferies.

Just from Caleb's guidance question. So the FFO is the same, but I looked at your '22, you assumed cost of debt was 3.4% for the full year and it's still 3.4%. Was it just the weighting -- there's a bit higher rate in the first half versus second half. So that's been a bit more weakness in the first half than you expected on the higher cost of debt?

Yes, correct.

Okay. And then if you look at the NOI, the comp NOI is pretty strong. It was up 4.2% to 3.3%. But if you take out the add-back at leasing and amortization trade lining was up about 47%. So that added about $3 million. If you take that out, there wasn't a huge increase in the investment EBIT -- on the NOI line. Is it just a function of the leasing volume that are done that you've got that higher add back of the amortization in the FFO property line?

So on the earnings slide, that doesn't include any accounting adjustments. So that's pure underlying performance of our NOI. So the 4.2% is based on essentially cash.

Okay. That's great. And then just a follow-up, [indiscernible] turnover you've had some acquisitions here, so it might not be like-for-like. But you -- obviously, specialty rents increased a lot and you bought more, but I think it said your specialties increased [indiscernible] of rental income. Was that just from acquisitions that the higher specialty or growth in specialty income exceeding the anchors?

Yes, it's Mark here. Two things. One is acquisitions because obviously, the assets we divested were smaller neighborhoods with a higher percentage of anchor income, and the ones we acquired had a slightly higher percentage of specialty income. So it's a little bit of a mix change. But also over time, because the specialty rent grows more quickly than the anchor rent, over time, we will gradually, as we have done, gradually see specialty rent become a higher percentage than anchor rent just naturally through the growth of those 2 lines over time.

Yes. That's good. And then just last period, you had 41 of 92 supermarket [indiscernible] 45%. What was the percentage at 44 out of not sure how many supermarkets you have now? [indiscernible] what's the percentage.

Slide, which sets that out is slide, which is Slide 34. So you can do the calculations on Slide 34. We set out the number of supermarkets in each period.

And the DRP is remaining [indiscernible] just a one-off for that having that underwrite is a DRP going to be back to sort of normal DRP this period?

No. We sort of have kept that underwrite on for a number of years now. There's nothing to it. It's a 1% discount to our price at time, and we think it's a good effective way of topping up to effectively pay for our development spend is how we really look at it. And we do have a lot of retail investors. The take-up is about half -- 25% and we underwrite to 50%, and that's been pretty consistent over the last few years.

Yes. And then just on the corporate costs, I think you said they went down -- or slightly up. The cash flow statement had $13.6 million versus $9 million, I think there was a restatement of $1.4 million, which was below the line before. What sort of going on that restatement of the sort of $1.4 million that was below the line before?

I'll have to come back to you on that one.

Okay. All right. And then finally, just on the revals, it seems most of the weakness came through in the subregionals. If your cap rates up near about 3 basis points higher than the [indiscernible] increase. But was the cash flows impacted more on the subregional assets than the neighborhood assets to get to those negative resales this period?

Mark?

Yes. Look, I don't think there was that skew. Overall, we had slight NOI growth in the [indiscernible] around 1% for the period. The real impact on the [indiscernible] is the cap rate expansion, not the NOI movements.

And it was pretty consistent, it wasn't -- we didn't discern them that much.

In fact, we are starting to see the NOI growth of the subregionals come back relatively strongly over the last 6 months. So not so much about income or about cap rates.

And as we've said before, the subregional sector is one of the most widely defined. So ours tend to be at the very smaller end of the subregional sector, and there are some that are much, much larger centers, so it's a wide range. But ours are the small ones, and there wasn't that much difference between either.

And then just finally, on the leasing majors gave as $8.4 million this half. What's the sort of increase? What is the expecting second half on the run rate for that?

So that's [indiscernible] and leasing CapEx, Sholto? So if you look back over the last couple of years, we've generally spent around $23 million per annum on leasing and maintenance -- it can be lumpy, as Evan said, so in particular periods, depending on how many deals we've done in the previous 6 months and just the timing of maintenance CapEx, but I'd sort of think about through the cycle around that $23 million, $24 million for the current portfolio, not using that as a forecast for the second half, but there will be a slight increase in the second half versus the first half. And that's all captured within the guidance.

Yes. All right. That's correct. That's helping.

Next question comes from Lou Pirenc with Jarden.

A quick question on the development pipeline. Apologies, Anthony, if I missed it. But what returns do you expect on those smaller developments and sustainability initiatives? Or is that really a maintenance CapEx as well?

To basically get on that slide except for things like the shopping center rebuild. I'm talking about Slide 23, where we had at least more and that was just the best place to show. Basically, we've got IRR hurdles and everything on that slide meets it. The sustainability, we have some that do a lot better and some -- such as some of the solar where the embedded network does very well. but some of the R22 gas replacements probably doesn't need it. But as a whole in sustainability, they all meet our IRR hurdles.

Great. And then just as a follow-up to Caleb's question earlier, which is more about the metro kind of bid-ask spread in terms of acquisition opportunities. Is it very different from the non-metro in terms of your own balance sheet? Or is it a similar kind of issue at the moment, where the bid ask where there's still too wide to really jump on opportunities?

No difference. Well, I think they're getting slightly better, but vendors still think the centers are valued at some prices this time last year, and purchasers aren't willing to pay as much as they were willing to pay this time last year because of funding costs. And that gap has narrowed now.

Your next question comes from Simon Chan with Morgan Stanley.