Vicinity Centres (VCX) Earnings Call Transcript

Thank you for standing by, and welcome to the Vicinity Centres FY '23 Interim Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Peter Huddle, Chief Executive Officer and Managing Director. Please go ahead.

Good morning, and thank you for joining us at Vicinity Centres' results call for the 6 months ended December 2022. Joining me on today's call is Adrian Chye, our Chief Financial Officer. . Before we begin, I'd like to acknowledge the traditional custodians on the lands on which we meet today and pay my respects to their elders, past and present. I extend that respect to Aboriginal and Torres Strait Islander people on the call today. I will start on Slide 5. Our interim FY '23 results reflects a continuation of the positive momentum delivered in FY '22 as well as our disciplined approach to delivering long-term sustainable growth. The Australian retail sector continues to enjoy elevated growth despite near-term uncertainty, and the residual impacts of the pandemic on Vicinity are now largely limited to the ongoing recovery of our CBD assets. During the half, we continued to deliver quality retail property management and leasing outcomes across our assets. We are firmly in execution phase of our retail and mixed-use development pipeline. We have strengthened our JV and third-party capital relationships, and our strong balance sheet and credit metrics continue to be a source of competitive advantage which enables us to invest in existing growth initiatives and, at the same time, fund potential accretive investment opportunities that align with our strategy. Adrian will talk to the financials in more detail shortly, but at a headline level, Vicinity delivered a net profit after-tax of $176 million for the half. At an operating level, we delivered strong results as the business continues to strengthen post-pandemic. Importantly, FFO grew 24% over the prior period, largely driven by 21% growth in NPI. At 25.7%, gearing remains at the low end of our target range of 25% to 35%, and 81% of our drawn debt is hedged. The Board declared an interim distribution of $0.0575 per security, representing a payout ratio of 79% of AFFO. And finally, our strong first half financial and operational performance has enabled us to upgrade our FY '23 full year earnings guidance. With the impacts of the pandemic increasingly behind us, I believe it is worth reinforcing Vicinity's competitive advantages or, said differently, our investment proposition. We have what we believe is one of the best asset portfolios in the sector. Chadstone is unashamedly the cornerstone of our business. Being one of the premier shopping centers globally, Chadstone is unrivaled in the Australian marketplace with sales rising to more than $2.6 billion by end of year '22. We are the market leader in the growing outlet sector, and we have ambitions to extend our leadership position. We have the best retail CBD portfolio of any Australian landlord, and we have actively invested in these assets during the pandemic to position them for full recovery. We are the leading Australian luxury landlord. We value our strong partnerships with luxury brand owners, and we are working together to expand existing and new luxury precincts in our premium assets. This year, our luxury sales exceeded $1 billion despite the absence of Chinese tourists. And we have more than 10 assets in key metropolitan locations with attractive retail and mixed-use development opportunities where substantial progress has been completed in master plan approvals. Under my leadership, our disciplined approach to balance sheet management will continue with low gearing, high near-term hedging, a well-diversified debt book and a commitment to maintaining strong investment-grade credit ratings to ensure we can access debt capital to fund growth opportunities. And our results today demonstrate execution across all our strategic priorities, which is delivering sustainable earnings growth through the cycles and for the long term. A 6-month period of sustained recovery and minimal COVID impact drove strong retailer sales growth which, in turn, led to a buoyant leasing activity and improved financial performance. And despite heightened near-term uncertainty, retailer confidence has remained high. The retail sector continues to be a benefactor of an extremely tight employment market and robust household income growth together with elevated savings rates. While we have seen some softening in the housing market, average house prices remain elevated relative to pre-COVID levels, which is continuing to underpin a wealth effect for homeowners. Importantly, we continue to see international arrivals increase for migration, tourism and education which, for us, will benefit our premium DFO and CBD assets. Conversely, we are yet to see material sales reduction resulting from recent interest rate hikes on domestic spending. However, we are mindful of the resetting of fixed rate mortgages this year and the potential impact this may have on discretionary consumption. While we are expecting the rate of sales growth to moderate in the second half of FY '23, our first half results has set a strong foundation for full year '23 earnings. Compared to international peers, the Australian retail sector has a degree of structural resilience. Australian shopping centers have always had a broader offer than overseas markets, including a range of nondiscretionary offers, such as grocery and fresh food, banking and other services. These tenants stimulate customer traffic and generate a higher frequency of visitation. On the supply side, the development or expansion of larger-format shopping centers remains constrained relative to prior years and decades. This is partly as a result of planning policy that rightfully favors existing centers around which communities and infrastructure have been built but is also fundamentally aligned to growth requirements of retail markets today. Consequently, Australian's premium shopping centers generally have lower vacancy rates than their global peers, with occupancy sitting at more than 98%. The role of the physical store is also expanding which, in turn, is driving increasing leasing demand and increased occupancy. We have said previously the future of retail requires an omnichannel offer. The function of the store is expanding to include showrooming, significant expansion in range of offers, provision of fulfillment and return of all orders and is overall a more cost-effective means of customer acquisition. Our national footprint of diverse retail assets positions Vicinity as a partner of choice with growth-orientated retailers who are able to leverage our network of convenience, CBD, outlet and premium centers. And of course, we are developing a number of our retail assets into thriving retail, commercial and residential precincts that not only meets market demand and provide further security holder value in their own right but collectively multiply the value created by each stand-alone asset. At Vicinity, we believe that having a sustainable business is critical to creating long-term value for all of our stakeholders. During the period, our sustainability program was once again recognized on a global stage. GRESB ranked Vicinity as the sector leader of Australia and New Zealand for listed retail shopping centers and third globally in its 2022 survey for the second consecutive year. And in the Dow Jones Sustainability Index' annual survey, Vicinity ranked eighth out of more than 450 real estate companies globally. As we look ahead, there is plenty more to do as we truly operationalize and embed sustainability practices into our business, and I look forward to continuing to share our journey on this. This half was the first full period with no COVID restrictions impacting trading in any states. Consequently, we saw very positive momentum across all of our sales categories and geographies. Improved portfolio visitation over Q1 and Q2 highlighted shopper preferences for a physical retail experience. Adding to this the annual growth rate of online sales, measured by NAV, continues to slow from 14.5% in June to 2.3% in October 22, and the latest data showed almost flat growth. In the December quarter, visitation, excluding CBDs, averaged 93% of 2019 levels. And on CBDs, we have been very pleased with the continued positive momentum. Visitation in the December quarter reached 80% of 2019 levels. International arrivals surpassed 60% of pre-COVID levels, with China's international borders recently reopening. We are optimistic the momentum of CBD recovery will continue. The confluence of improving visitation, properly functioning supply chains and growth in both sales and margins for retailers has supported retailer confidence, and we have seen leasing activity increase as a result. This has also supported improved cash collections. During the half, collections of gross rentals billings strengthened to 97%, up from 93% for the second half of FY '22. Major and national retailer collection rates are now at pre-COVID levels. And while it remains an area of ongoing focus the SME collection rate has improved considerably to 92%. And finally, outstanding COVID rent relief negotiations are largely agreed. Retail sales growth in the half almost defies the reality of rising interest rates and household inflationary pressures. Total portfolio retail sales for the half were up 20% compared to 2019 or 6.3% on an annualized or CAGR basis over the 3-year period. Importantly, specialties and mini majors recorded the highest growth by category with a combined CAGR of 7.3% compared to 2019, which ultimately resulted in improved leasing margins. Apparel and footwear, leisure, jewelry and retail services recorded standout performances, with consumers continuing to invest in themselves post-pandemic. Food retail growth was strong, delivering 10.5% CAGR, in part driven by price inflation. Cafés and restaurants continue to improve, delivering a CAGR of 7.6% as shoppers choose to spend more time in centers and enjoy connecting in person. This is particularly pleasing given cafés and restaurants are predominantly SME owned and operated. Demonstrating the value of a regionally diverse portfolio, our Queensland assets have performed exceptionally well, with local and international tourism to the state boosting performance and, of course, Chadstone continues to set the standard for retail. This global destination continued to deliver strong growth with annual sales more than 10% above pre-COVID levels, justifying the ongoing retail and mixed-use development activity. Part of Chadstone's success is attributed to the performance of luxury retailers. Our 63 luxury stores have delivered a 16% CAGR over the past 3 years. And with more brands coming to market, growing store footprint and continued expansion into a younger customer market, we are confident in the outlook for luxury long term. Turning to our leasing performance. Our leasing team executed its highest level of deal activity since Vicinity was formed in 2015, negotiating 833 deals in the period. Consequently, occupancy improved 30 basis points since June '22. A significant focus has been on converting shops on holdover to longer-term leases. In the half, holdover is reduced by almost 200 stores. And as a percentage of income, holdovers are down to 5.7% from 7.4% at June '22. Leasing spreads were flat for the half, improving from negative 4.8% for FY '22. More than 96% of deals were negotiated with greater than 4% annual rent increases, and the average new lease term was 5 years. Spreads across Chadstone and the DFOs have returned to high single digits, which is reflective of the favorable trading conditions and strength of those assets. In fact, at our recently acquired DFO Uni Hill and Harbour Town Gold Coast, we have executed on key tenant remixing not only to enhance the offer of those centers but we have also delivered double-digit leasing spreads, further enhancing the original investment case for those assets. In summary, for the half, we have executed more leasing deals by total number and total dollars at better leasing spreads and also increased occupancy. Importantly, we have done so by introducing exciting on-trend retailers that will drive greater customer visitation and sales and which we can expand across our national network of retail centers. I'll now hand the call to Adrian to discuss our financials in more detail.

Thanks, Peter, and good morning. Statutory profit for the half was $176 million, reflecting a strong rebound in FFO and a modest valuation decline. As Peter outlined, the FY '23 interim result was driven by our focus on sustainable growth. It is underpinned by quality operating metrics and prudent financial stewardship, and this is reflected by the 24.1% and 20.5% growth in FFO and NPI, respectively. And of course, our strong income growth also benefited from the absence of COVID lockdowns as well as the sustained resilience of the retail sector during the half. Our cash collection rate of 97% of gross billings is approaching pre-COVID levels and was up 18 percentage points on the same time last year. This was a key driver of the $78 million uplift in NPI. Adding to this, the strong retail sales environment, together with our persistent focus on collecting prior period billings resulted in a $25 million reversal of prior year waivers and provisions. Also driving NPI growth in the half was positive rental growth, supported by our standard lease terms which incorporate fixed annual increases of between 4% to 5% for our specialty leases and improving leasing spreads. Percentage rent also increased, reflecting our successful luxury strategy and the extremely strong sales growth and an acceleration of the recovery in ancillary income, benefiting from the strength and rebound in visitation and sales in the half. It's important to note that FY '23 NPI is positively skewed to the first half due to the benefit of prior year waivers and provisions together with seasonality, timing and the expectation of a softening in trading conditions in the second half. Net interest expense increased by $6 million, mainly due to transactions and development completions. And naturally, we expect a further increase in interest expense in the second half. And while net corporate overheads increased $6 million in the half, principally due to timing and one-off impacts, we expect full year '23 net corporate overheads to be in line with FY '22. On maintenance capital and leasing incentives, as in previous years, the majority of this spend is expected to be weighted to the second half. And consequently, we are still forecasting a total spend of around $100 million for the full year. The FY '23 interim distribution per security of $0.0575 represents a 22% increase in the prior period, and we expect the full year distribution payout ratio to be towards the lower end of the target range of 95% to 100% of AFFO. Moving on to valuations. For the 6 months to 31 December 2022, the portfolio recorded a modest valuation decline of 0.7% or $109 million, with the weighted average capitalization rate softening by 3 basis points. Collectively, our premium asset portfolio, comprising Chadstone, the CBD assets and the outlet centers, delivered positive valuation growth, reflecting buoyant leasing activity and quality outcomes. The strength of Chadstone was even further demonstrated this half with a $53 million valuation uplift driven by both income growth and a 12.5 basis point tightening of the asset cap rate, following development approvals during the period. The regional, subregional and neighborhood portfolios recorded valuation declines, reflecting softer valuation metrics, which were based on recent transaction evidence. Turning to our capital structure. Vicinity's balance sheet remains in great shape and provides us flexibility to navigate periods of uncertainty and the capacity to find accretive investment opportunities. Gearing of 25.7% remains at the low end of our target range. We have no debt expiring in FY '23 and minimal drawn debt expiring in FY '24. Our hedging levels are above 80%, and we have ample liquidity of $1.3 billion to fund our committed projects and near-term debt expiries. Our debt duration is 4.5 years based on debt drawn, and we entered into additional $500 million of hedges during the period, taking our hedged debt duration to 4.2 years. We retained our strong investment-grade credit ratings of A and A2 with Standard & Poor's and Moody's, respectively, both with a stable outlook. Thanks, and I'll now pass back to Peter.

Thank you, Adrian. Turning now to our development pipeline and our new leisure and dining precinct, The Social Quarter at Chadstone, will open March 1 this year. This development extends the current entertainment and lifestyle precinct into a contemporary indoor/outdoor environment with views towards the Melbourne CBD skyline. We look forward to formally welcoming me the Officeworks team as the development of their new head office is scheduled to be complete in the coming months. Also at Chadstone, we have commenced the new 9-level One Middle Road commercial tower that includes the new Adairs head office, along with a refurbished and expanded fresh food and our fresco dining precinct. This is Vicinity's first fully integrated mixed-use development where the office tower will be integrated with the retail precinct at multiple levels of the center, and completion is expected prior to Christmas 2024. Also during the period, we opened a new Coles-anchored fresh food precinct at Box Hill Central. This project includes upgrade to mall finishes and the introduction of dual-frontage restaurant precincts, which opened to Carrington Road. The new development is fully leased and trading well. Construction of a new 4,000 square meter office podium above the center is complete and fully leased to Hub Australia. And the site is expected to open at stores next month. At Bankstown Central, we also opened a Coles-anchored fresh food precinct known as the Grand Market, and we expanded the mini major precinct to introduce a number of exciting new tenants to the center. The completion of projects at both Box Hill and Bankstown paved the way for the next phase of their development, unlocking of the assets for major mixed-use projects that have been authority approved. At Chatswood, we have commenced early works for the lower ground fresh food mall and dining precinct upgrades. The development will revitalize and expand the existing fresh food mall, while the dining area will include a range of cafés, fast food and quick-service restaurants. This is the first step in a major redevelopment which, subject to relevant approvals, includes an elevation of the center's offer, including expanded luxury precinct as well as a new rooftop office village. Moving now to our earnings guidance. Given the strong half year results, we are pleased to upgrade our FY '23 earnings guidance. FFO per security and AFFO per security are now expected to be in the range of $0.14 to $0.146 and $0.118 to $0.124, respectively. Even when adjusting for the benefit of prior year waivers and provisions, our upgraded FY '23 guidance is above the top end of our original guidance range. We are targeting a full year distribution towards the lower end of our payout range of 95% to 100% of AFFO. Before I hand the call over to the operator for Q&A, I wanted to touch on my recent appointment as Vicinity's CEO and Managing Director. Naturally, I'm honored to be leading a company with such a strong team, a prized portfolio of assets and an organization with significant potential for growth. As discussed today, I believe Vicinity has the right strategy in place to deliver long-term growth. And under my stewardship, we will have an even greater emphasis on driving a performance culture that is focused on property excellence, profitable growth, customer centricity and disciplined capital management. Having been with Vicinity since 2019, my feet are already under the desk, and I'm motivated to get going on delivering our priorities and growth agenda. I look forward to sharing more on this at the appropriate time. Thank you, and I'll now hand the call over to the operator for Q&A.

[Operator Instructions] Your first question comes from Sholto Maconochie from Jefferies.

Congrats on a strong result. Just you touched on the second half's potentially softer trading conditions, how is January trading, if you got that figure available?

Sholto, it's Peter here. We haven't rolled up January at this stage. But if you -- our indications in the marketplace is that sales are softening a little bit, particularly after the last interest rate rise in February. So hence, the reason why we're expecting -- we had a very strong, obviously, 6 months to the end of December. We started to see a softening in December sales with still growth, and we expect that through the second half.

Okay. And second question, how are you progressing on bringing capital partners to develop the pipeline? And would you consider any asset sales going forward as well?

Yes. Look, in terms of the capital partners, we've commenced the process in the middle of January and where that process is primarily for Buranda which, as we announced, we received our DA approval on that just before the end of the year. We have substantial approvals in place for Box Hill, and then we're also progressing substantially Vic Gardens. So for that, our ideal strategy is to bring capital partners in. So Sholto, we've commenced that process. We're in that assessment at the moment. And as soon as we get to an outcome, we'll advise the market accordingly.

Your next question comes from Lourens Pirenc from Jarden.

Can I just ask about the leasing spreads? You called out and included as improvement that you called out Chadstone and the DFOs very positive. So where is the weakness to offset that? Can you talk about that?

Yes, sure, Lou. So essentially, if you break the leasing spreads down a little more, we're probably positive 3% across our premium assets, including our CBDs, Chadstone and the DFOs, and probably around about the negative 3% to 3.5% across the rest of the core portfolio. So it's not too dissimilar to where we were in pre-COVID conditions where the premium portfolio is performing extremely well. And there's still a bit of negative leasing spreads in the core portfolio, but even if you look at our core portfolio, it's substantially better than it was over the last number of reporting periods, particularly even just before COVID as well. But that's generally the split.

And then second question, can you just highlight -- you mentioned the ancillary income is coming back. Where are you compared to pre-COVID levels roughly in terms of that ancillary income?

So Lou, from our point of view, we're right on the number, to be honest. We're essentially at FY '19 ancillary income levels. I would add we've put some capital to grow some of those business lines, including our media business, which has performed well. And we've still got some -- a little bit of ways to go in terms of controlled parking and some of our casual mall leasing space, but essentially, we're at the same number as FY '19, which is about a bit over $100 million.

Your next question comes from Simon Chan from Morgan Stanley.

I was hoping Adrian could elaborate on his comments about the skew of earnings through the first half. Because I was just doing some quick math, it looks like even if I strip out the provision reversal, your guidance midpoint-to-midpoint is implying second half to go backwards on first half by about $40 million -- $35 million, $40 million. I get interest expense will be a factor. But like, what else is there for you to think you're going to go backwards by $30 million to $40 million?

Yes. Thanks, Simon, for your question. Yes, you're right, we are expecting a pretty significant skew from first half to second half. If I just break down those components, interest expense, we're expecting about $10 million to come through, through increased weighted average cost of debt and also volume driven into the second half. . And then in terms of -- you've already talked to the $25 million of prior year waivers and provisions. There's probably about $25 million of other items which are skewing the results. They're kind of driven by about 4 key factors. The first one is around loss of rent. So we've got, particularly with Chatswood, fresh food kicking off in this half. There will probably be an increased loss of rent going into the second half. Ancillary income tends to be a little bit weighted to the first half as well given Christmas trade, so car parking and CML tend to be a little bit more heavily weighted to the first half. And then marketing and outgoing, there's a slight skew there as well. And then finally, as Pete touched on, we are expecting some softening conditions in the second half. So we've made an allowance for some softening in the second half in that result. So that should give you an idea of how we're thinking about that split. But I guess how you're thinking about your numbers is similar to what we're thinking about.

That's good. Peter, just wondering if you've got any update on your funds management aspirations because I think Dave McNamara has been there for about 12 months now. I'm just wondering what sort of progress have you guys made on that side of things.

Simon, maybe I was a bit vague to answer that first one. The process that we're in the moment, which Dave is leading, is an appointment process for strategic advisers with us to essentially bring that third-party capital in for Buranda, Box Hill and potentially Vic Gardens as well. So we think that process will take a couple of months. We're in the closing stages of appointments, and then we will be tapping into those marketplaces. So that's probably our from -- post our reviewing of strategy in terms of how we want to kick off our funds management, this is our first step into that arena. Hope that's helpful.

Yes. That's clear.

Your next question comes from Ben Brayshaw from Barrenjoey.

Congratulations on your appointment as CEO. I was wondering if you could talk about the recovery profile of CBD, visitation sitting in sub-80% across the portfolio. You mentioned international was picking up. So how close are CBD assets to their income being stabilized in the last 6 months?

Ben, first, thanks for your comments. And secondly, with CBD, we're happy with the way CBDs are at the moment. They're still nowhere near where we need them to be. So maybe sort of a bit more further breakdown, traffic's up to about 80% of pre-COVID levels. Our valuations are still sort of 22% of pre-COVID levels. Sales are improved. It depends on the asset. So they're probably around about 10% to 15% down on pre-COVID levels. And so what we think is -- and maybe for some other context, particularly in Victoria, which I think, to be quite frank, has done a better job on driving business sector CBD. We've got traffic back to 100% of pre-COVID levels on weekends. So that's sort of the broad scenario. In terms of our provisioning, a majority of what we're providing for, which is around about that $30 million mark for the rest of the year, is related to ongoing sustainable initiatives for CBDs. We still think it's going to take a period of time until CBDs come back to whatever the new normal is going to be for them. Opening of the international borders is clearly going to help, return of CBD office workers in a more meaningful way is also going to help. But fundamentally -- I'm sorry, the other thing, Ben, is we've spent a lot of time in remixing our CBD assets to really take advantage of what we call, let's say, a [ preferred ] destination of shopper. So we don't think -- we think it's not going to occur in this second half and we made provisions appropriately for it. So we would love to have a crystal ball, but I think it's going to take a little bit longer, and it depends really on CBD office worker return and the return of international tourism.

Could you clarify as well, I thought I heard you say in the presentation, but perhaps I didn't get this down correctly, that Chadstone sales were up 10% versus pre-pandemic, just seemed a little soft, if you could comment on that, please?

Chadstone sales are pretty close to $2.7 billion now. So on a comp basis it's -- bearing in mind, that substantially went down, Chadstone sales. So Ben, I'll come back on the absolute comp basis for you just after the call, but we're about double-digit -- a small double-digit increase in sales.

Okay. It's lagging the rest of the portfolio. I was just wondering if you could maybe talk about some of the factors there that maybe have weighed on the recovery in relation to Chadstone?

The fundamentals around Chadstone, a lot of what's driving Chadstone at the moment, one, obviously, we've done significant remixing through Chadstone. We've increased the size of many stores and it's had exceptional sales performance through its luxury categories. So across all categories, we've had strong growth in sales across Chadstone, but really the luxury categories are growing at circa 15% CAGR since 2019 at Chadstone. So that's what's also helped us deliver to that close to $2.7 billion sales result.

Your next question comes from James Druce from CLSA.

Do you have an occupancy cost number now that sales have been pretty clear for 6 months?

We didn't report one, James, but it's circa around 14%. And to Ben's question before, if you adjust for the strength of luxury sales, which obviously have an influence on occupancy costs, and if you exclude it, you're closer to around about 14.8%.

Yes. Okay. Does that mean the rents are up 10% since pre-COVID and sales were up 20%? Is that fair number?

So probably, it's pretty -- there's always a bit of a time gap between sales increases and your ability to adjust rents both on the way up and the way down, but it's probably broadly similar to those numbers.