Earnings Call: H1 2018

Feb 27, 2018

Thank you for standing by, and welcome to the PreSync Properties Half Year Results Conference Call. All participants are in a listen only mode. There will be a presentation you. I would now like to hand the conference over to your speaker today, Mr. Scott Richard, CEO. Please go ahead. Thanks, Amber, and good morning, everybody, and welcome to the 2018 interim result briefing for precinct properties. Am Scott Richard. I'm the Chief Executive for Precinct, and I'm also joined today by George Crawford, Precinct's Chief Operating Officer and Richard Hilda, Precinct's Chief Financial Officer. The first half of the 2018 financial year has been an active one for precinct, with markets continuing to perform well, and with further progress made on our major initiatives. The past 6 months have seen us take substantial steps forward. We're very pleased with our result, In particular, the quality of the result with revenue and net property income growing as a consequence of strong occupier markets. The program for today's call is outlined on Page 2 of the presentation. I will provide an overview of the highlights of the results before discussing the strategic progress we have made over the past 6 months. I will then discuss Precinct's development portfolio and provide an update on Commercial Bay and Von Campus. Following that, I will hand over to Richard to provide an overview of the financial results and capital management initiatives in the period. George will lead us through Section 4 of the presentation covering the property markets and our portfolio performance before I provide some concluding comments. Moving to the highlights page. The most notable outcome over the past 6 months has been the strong growth in operating income, which is up 3.8% on the prior period. Similarly, net property income is up 3.7% with both metrics benefiting from a strengthening Wellington market and solid like for like revenue growth across the portfolio. As I mentioned at the outset, it's been an active 6 months and our focus on capital management initiatives is an example of that. We've concluded 2 key initiatives with a successful convertible note issue of 150,000,000 and a $100,000,000 retail bond offer. Pleasingly, the portfolio continues to benefit from strong occupier markets. As businesses continue to expand and employee numbers grow. As at 31 December, the portfolio occupancy remains very robust at 99 cent, and the weighted average lease term has extended once again to 8.8 years. The benefits of owning well located and high quality real estate is evident with growth in rental levels above valuation and contracted rents. Turning to section 1 strategy progress. Page 5 focuses on the 3 pillars of precinct strategy, which we outlined in our full year results last August. These pillars consist of our people, operational excellence, and developing the future. Consistent with that strategy, we have outlined on this page the progress that's been made in each of these aspects. In terms of our people, we are currently recruiting for a commercial bay retail management team and are very encouraged by the quality of the people who want to work with on this asset. We have updated our diversity policy and recently completed our annual intern program. Initiatives within our operating business include the launch of a sales campaign for 50% of the ANZ center, The 250,000,000 of capital management initiatives, which I've mentioned already, as well as generators further growth with a new office set to be launched into the and Maine. Further operational excellence has been made with our Wellington portfolio demonstrating strong growth following occupier demand. In terms of our development activities, the most notable achievements in the period include the progress made on retail commitments at Commercial Bay and Bowen campus reaching 100 percent occupancy following the New Zealand Defense Forces entry into an extended 18 year lease for the Bowen State Building. Turning to Page 7 in our development summary. This slide is very important in articulating the stage that precinct is at with regards to our development activities. To date, we have committed to around $1,000,000,000 of development with pre commitment sitting at around 80%. Of that development, which is currently underway, we have a blended return on costs I. E. Development profit of 27 percent and a yield on cost of around 7.5%. Importantly, as we look to the next phase of our development activities, we feel it important to set out what we believe our targeted returns will be. The next stage of development activities will include the 2nd stage of Vineyard Quarter 1 Queen Street in Auckland And Bowen Campus, balance land in Wellington. Combined, these developments will provide around 30,000 square meters of additional office supply across Auckland and Wellington. Those targets will be to continue to seek development profits of 15% and yields on cost of around 7%. Now turning to Commercial Bay. As discussed already, the retail at Commercial Bay is attracting strong interest from retailers demonstrated by our progress made in the period. And we are pleased to announce today that we are now sitting at 60%. Most pleasing, however, has been the quality of the retailers who are committing to the center. With a retail mix that will be unique and of a very high standard. The return metrics remain unchanged with a forecast yield on cost of around 7.5 percent and a development profit in excess of 30 percent or over $200,000,000. Turning to page 9. To date, we have found that the interest in the food and beverage opportunities has been significantly ahead of our own expectations. We believe this is because of the several newton New Zealand brands either committed to or currently considering a commitment to the center. An office leasing update is set out on Page 10. Total office commitments remains at 66 percent, which is consistent with space in the tower. We currently have negotiations at various stages for around 6000 square meters, which would equate to around 15 percentage points of the tower. As a reminder, our feasibility assumes the tower will be 90% leased on completion with void periods assumed of between 1 2 years for the remaining 10% of space. Turning to page 11. As you may recall, in August last year, we announced that we were delaying the opening date of the retail center following independent advice that the likely completion date for the retail center was going to be at the end of quarter 1, 2019. For completeness, the contract date for completion of the retail center is November 2018. And our main contractor has advised recently that their program's date for completion is December 2018. Our independent advice is that a December completion date is unlikely. The contracted date for completion of the office tower remains in July 2019, albeit that we are beginning to become a little concerned that this date is challenging. Crit to achieving this date will be the rate at which the facade can be installed as this fundamentally drives the time frame for completion. Importantly we are continuing to monitor closely the production rates on-site and remain comfortable with the provisions of the construction contract and how that protects precinct from the risks and costs of potential delay. An update on Bowen Campus is outlined on page 12. In the period, we have completed the leasing for the remaining vacant laws with the New Zealand of thin force taking elites over all of the office space and some amenity space within the Bowen State Building. This takes the entire development The construction activities are progressing very well on-site with the main contractor performing to a very high standard. The project remains on budget and on program. Turning to Page 13 and our future opportunities. The business is really which are held within the business. These are either assets acquired at a low point in the cycle, or development rights, which are based off residual land value calculations, ensuring that the next stage of developments will be both value and earnings accretive. The most advanced of these opportunities is the 2nd stage of Vineyard Quarter. We have 3 remaining sites at Winyard Quarter and the next stage is anticipated to consist of around an 8000 square meter office building. Targeting a 50% pre commitment, we anticipate commencing this project within the next 6 months. The next most advanced development opportunity is 1 Queen Street. We have considered a range of development opportunities for this asset over the past 12 months and have determined that the most optimal use to be a mixed use development comprising hotel and office uses. On that basis, we commenced a competitive process seeking suitable hotel operators and have progressed to now be in a position where we are negotiating with our preferred operator. We feel confident in the location. The opportunity to convert the building to a hotel use and the benefit that a hotel offering will provide to commercial bay generally. The remaining opportunities within the portfolio are held at Vineyard Quarter And Bowen Campus. Windyard quarter stages 3 and 4 offer a further 20,000 square meters of NLA made up of either 1 or 2 buildings. These developments will be targeted towards future growth and innovation or corporate occupiers seeking a standalone building. The commencement of these stages will be square meters of office space, which is suitable for either the Crown or corporate occupiers. This stage is currently being designed with the opportunity to develop high quality large floor plates with high efficiency ratios. The existing annex building is currently being demolished to allow for construction to commence. Similarly our quarter, any commitment to proceed will depend on a level of pre commitment. I'll now hand you over to Richard to take you through section 3. Thank you, Scott, and good morning, everyone. Slide 17 sets out our financial performance for the half year, including The completion of 1 year to day 1 and improved occupancy in our Wellington corporate assets resulted in net property income being $1,700,000 higher than the comparative period. Offsetting this was an anticipated high tax expense for the first half, which I will discuss shortly. A further devaluation at 10 Brandon Street in Wellington of $14,700,000 and an unrealized loss on interest rate swaps, resulted in a lower net profit after tax for the period of The business continues to be highly active and remains on track to deliver full year earnings of around $0.63 per share. Which is unchanged from August. Slide 18 provides a breakdown of net property income after allowing for Winyard Stage 1, 10 Brandon Street And Commercial Bay, including the associated foregone income at HSBC House. Net property income on a like for like basis was 3.1 percent higher. An increase in occupancy at State Insurance Tower And Dimension DataHouse net property income across these assets increased by around 12%. In both Wellington and Auckland we continue to see good levels of leasing inquiry and market rental growth, which George will talk to you soon. Turning to Slide 19. Tax expense for the period was $2,100,000 higher than the comparative period. This is due to a high level of deductibles in the prior period due to the disposal of fixtures and fittings at Bowen Campus Stage 1 in October 2016. Our guidance on the effective tax rate for the 2018 financial year is unchanged at between percent. Our high level deductibles are expected in the second half due to additional leasing fees and the disposal of fixtures and fittings at Bowen Annex and number 3, the tariffs. Finally, on capital management. Has been an active 6 month period with the issue of a $150,000,000 subordinated convertible note and a $100,000,000 senior secured bond. We were very happy with the final terms and the level of demand shown for both issues. For a weighted term of around 4 years. This provides sufficient capacity to deliver all current developments and near term opportunities such as Winyard Stage 2. Recapping on the convertible note, we continue to think this is a capital management solution, which is well suited to pricing strategy. Importantly, should the capital not be required at maturity, Preasing maintains the flexibility to not convert the notes to equity and instead repay the notes in cash. Gearing at December, which disregards the convertible note has fallen to 23%. The sale of a 50% interest in the A and Z center will, if successful, reduce our level of gearing and provide fell in the period as we continue to draw on borrowings to fund our developments. Hedging currently sits in the upper half of policy and we remain comfortable with our current position. I'd like now like to hand over to George who will take you through the remainder of the presentation. Thanks, Richard, and good morning, everyone. As Richard has just mentioned within the financial results, our investment portfolio has performed very well over the last 6 months. This has been particularly the case for our Wellington corporate assets, which have benefited from strong occupancy and good rental levels. As outlined on Page 22, we are completing new leasing overall around 2% ahead of valuation rents. This indicates continued strength in the market with the portfolio now sitting at around 5% under rented. This strength is also seen in the market rent reviews completed during the half, which represented an average lift of 8.3% compared to the previous contract rentals We continue to have strong portfolio occupancy sitting at 99% for the half year. The 8.8 year portfolio average lease term has once again lifted to a new high for the business on the back of the lease term for balanced state increasing to 18 years. Turning to the market overview on page 25. Auckland remains supply constrained we think that the new supply in the pipeline will meet good demand. As we noted at the full year result, we continue to see occupiers adapting to the supply constraints, by increasing their occupation densities was probably a slowdown in decision making before Christmas, with election uncertainty and businesses choosing to defer major decisions. This year, we are generally seeing a good level of inquiry and believe there is increasing levels of business confidence, which should be positive for the market for 2018. Turning now to the Wellington market on Page 27, we are seeing solid occupier demand good quality, strong buildings continue and resulting in very low levels of aid rate vacancy. We think the combination of the reduction in supply and the confidence in Wellington from the change in government should provide continued support for both the occupier and the transactional markets in Wellington. Turning to page 28, we have undertaken a comprehensive analysis of our options for Tan Branden Street. We have wanted to make sure we have a very good understanding of all the options before committing any further capital. As Richard has noted, based on an assumed strengthening of the building for office use, we have written down the value of 10 Brandon Street Further, nicely at $7,000,000. However, no commitment to further capital spend has been made as yet and will depend on development being feasible in its own right. In the same way as we would assess any other opportunity. Finally, before I hand back to Scott, our co working investment generator has had a busy period with the successful launch of its Vineyard quarter operations as part of the grid AKL Innovation precinct. This has more than doubled the space, which generator manages, demand for that space is tracking ahead of our expectations. Generator has now committed to the 3rd Auckland location, Generator House in Brittle Mart, which the business is looking forward to launching midyear. I will now pass back to Scott to conclude the presentation. Thanks, George. While recent volatility in global capital markets shows that uncertainty remains, We are buoyed by the trend of emerging and sustained growth in global markets. In New Zealand, we see stability emerging following the change in government last year, and the continuing strength in occupier and investment markets. We continue to believe that precinct is well positioned relative to our markets and following capital management initiatives over the past 6 months. We also believe we have a very strong balance sheet to take the business forward. We're confident about our position. Our developments are tracking well with construction occurring under fixed price and fixed program contracts with strong inquiry levels. And our portfolio is demonstrating the benefits of owning premium quality real estate and strategic locations. Our strategy is clear and we think it's working well. I'd like to thank you all for joining us today, and we're happy to take any questions. Thank first question comes from Joshua Dale from Craig's Investment Partners. Please go ahead. Good morning guys. Just a few questions for me. Just on Commercial Bay Office on the slide 10, you're right that commercial terms remain consistent with feasibility assumptions. It has been no progress in the tower over the last 6 months. What are the risks to having to revise those rental rates assumed at feasibility so that you can ensure occupancy? Thanks, Josh. Yeah, I think we in terms of commercial we noted a pause and, an elongation, I suppose, in negotiations that were occurring in the back half of last year. And I think there's a lot of that was to do with change of government and, and businesses just sort of waiting to get a bit more certainty The negotiations that we've got underway at the moment, confirmed that they are terms which are very consistent with our feasibility. To date with all of the deals that we've done, as we've announced previously, our terms were sort of 3% of head of feasibility. So We're still feeling very good about where the rents are sitting, and we're feeling very good about getting the next tranche of space away. But, you know, do acknowledge that in that back half of last year, there was a pause in deals that have taken a bit longer to get done. Okay, thanks. And just if full year result last August, you announced that Four floors were under negotiation then you give us an update on where those are at and a bit more color on any negotiations that fell through? Yeah, look, we haven't really had any deals for through. And, and so it's sort of status quo remains in the sense that the negotiations have taken a bit longer, than we expected. But, you know, again, the level of inquiry still remains very good. For those occupiers that occupy sort of a floral or less. We feel like we're sort of just now coming into the zone where they will consider what their options look like if they have expiry that's 12 months out, then we're starting to see, sort of smaller occupiers really be interested in some smaller suites or occupying a single floor So again, feel feeling good about where we ran on commercial bay. We would have liked to have got, you know, a couple of deals away, but but we just haven't been able to get there in time before the result. Okay. And just on the additional leasing you made on the retail side, were those rental rates achieved in line with feasibility as well? They were actually ahead of feasibility. So the the demand we're finding on the retail is incredibly strong. And it's really a case now of just getting the mix right there's demand across the whole plan, and these names against every tenancy And at the moment, the important thing is focusing on getting the right retailers in the right location, ensuring that we sort of get that unique mix that we've always wanted a Cbd center. Okay, great. And just lastly from me, does your expected development margin incorporate the $27,000,000 Queen Elizabeth Square acquisition just recently settled? Yes, yes, it does. Yes. Okay. That's great. Thanks guys. Thanks, George. Thank you. Your next question comes from Angus Simpson from UBS. Investment Bank. Please go ahead. Good morning. Hi, Angus. Just quickly, I might have missed apologies, if not. Did you have the FO number per share for the first half? No, we didn't. We'll beat it on a full year basis. Okay. Can you give me a sort of sense of the adjustments on the maintenance CapEx etcetera, then there's a rough guide that was incurred in the first half? Yes. It's within our cash flow, there's about $7,000,000 in there. There's a large part of that relates to the RFP assets, passed through all my peer. Which some of the works undertaking there. But it's pretty consistent to previous years in what our policy of team pursuit of operating income. Okay, thanks. And then Next question. Just with regard to generator, I see that's been excluded from the just real profit calculation. Is that going to be the policy going forward? And then also what, I guess, what do you expect sort of the run rate of, profit will be or when will that turn profitable? Yes. Magnus, it's George here. So in terms of, so second part of your question around the run rate, So sitting at a $500,000 loss for the half year, which reflects the trading up of the, when you're a quarter operations, which were launched in September. So we expect that sort of run rate to be similar for the second half of the year, as occupancy gets to breakeven and then into profitability. I'll maybe ask Richard on the kind of on the distributable profit. Yes. The view is that it's very much in a growth phase with the additional site and all the new space that they've taken at Winyard as well. I think as it moves transitions to more of a stable business, that will be reviewed. Thanks. And then just last question, just on the comments around the delays, which you previously flagged for the Commercial Bay Retail, what's the assumption around liquidated damages? Should we just assume that all rent that you would have received for that period will be paid through to you guys Yes, look, we probably don't want to get into details around, the construction contract. But we are are comfortable with the contract. We're comfortable that the provisions within there protect us and effectively keep us whole. Okay. Thank you. And then just, the moment there's, I guess, such as this guideline is, the September versus the November, if they delivered in December, would there be liquidated damages payable to you? Correct. Thanks. That's all. Thanks. Your next question comes from Hayden Stryker from Forsyth Please go ahead. Hey, good morning guys and congratulations on a solid result. Just a few ones from me. Can give an update on timing with respect to the redevelopments of the other 3 Crown Assets in Wellington outside of Bohn Campus? Pastoral, mayfair, and number 3, the tariffs, given that the crown sort of indicated they need that space in the short term. And then just secondly, just sort of further on from Gus's question on Kombay. I suppose if you've taken a position internally that timing for the tower might move out. At what point does that sort of impact your kind of, commercial negotiations with moving tenants and moving tenants around because a big chunk of the tenants are coming out of the existing portfolio, which you can obviously house, but someone like DLA Piper who's coming out of another building. Can you just sort of walk us through the practicalities of that? Yeah, sure. Thanks, Hayden. In terms of the RFP timing, 3, the tariffs will be getting underway, mid this year. Pastoral house will be getting underway late next year, and May Fairhouse will be getting underway at the start of 2019. And so, some of those, some of that sequencing has changed, and that was really a consequence of the earthquake and, and the Crowns sort of requirements to just shift their timing around, but those times are now locked in. In terms of commercial bay, look at this stage, as we've said on the call, contracted date completion is July 2019. And as I mentioned, it really does depend on just the pace at which the starters installed. So that's just started going on the tower. So we'll be keeping a really close eye on that over the next, few months. For all of the occupiers that are coming into the tower, they have, lease terms, which extends quite a bit beyond the completion of the office tower. So we do have a lot of comfort around our ability to absorb some delays if there is some And to give you, I suppose, a bit of a sense of that, we don't have anyone that's, that needs absolutely get into the tower within 6 months of the targeted completion date. So we do have quite a bit of room there, headroom in respect to potential delays. Cool. Thanks guys. And just one more from me. Just on HSBC, in terms of the office and hotel, components there. Are you still targeting $150,000,000 as the additional spend? And that number you about in the presentation for future capital projects as a 7% initial yield that, is that kind of like a blend across all those projects or you'd be targeting a 7% yield on HSPC as well? Yeah, look, I think we're, I mean, certainly at an aspirational level, I think we should be targeting, you know, 7% yields on end of projects. So, that's that's what our that's what our goal will be. We think if you're going to put capital at risk, you ought to be getting a return around that. The extent to which the capital required for 1 Queen Street, and whether it's 150 or higher, will depend on the number of rooms that are included in the hotel. So you'll spend on the hotel use is higher than your spend on office. And so we're just working through what top to look. The 150 would be if we do a sort of half and half, if we do 2 thirds hotel, 1 third office, you might see that $150,000,000 increase a little bit. Your next question comes from Nick Ma from Macquarie Group. Please go ahead. Hey, guys. Just on the potential sales half of answered, will you guys intend on managing that and hence generating a property management fee for investors, or is that the manager itself? So the arrangement would be that the management company would provide property management services. But as per the current arrangement with pre sync that's on a cost recovery basis. So, the co investor that comes in would get the benefit of having an arrangement, which is purely cost recovery with complete transparency. That's the arrangement we have with precinct. So there's no upside for precinct investors from the fact that it's going to be a co investor in there? Not from a management fee perspective. No. There's no I mean, we're not looking to generate management fee the benefit from management fees for either the management company or precinct. Okay. That's cool. And then just in light of that and obviously the targeted projects you've got, for the future pipeline, what's your current thinking about where you would like gearing landing, obviously you've got the flexibility around the convertible note to move it kind of 5%. Yes. Well, I mean, we think, gearing in that sort of 30 to 35 range, We're not uncomfortable with that. We've got an SRN policy, which sits an upper limit, at sort of 37%, 38% sort of managing the balance sheet within that range is something that we're focused on the long term and matching capital out of initiatives like A and Z at a hopefully a tight yield and into development opportunities that a 7 plus yield kind of makes sense to us. So, that would be for us a nice piece of portfolio construction. Yes, that's great. And then just on, of backfill leasing, how are you going there? And there's a bit more space, I guess, coming up out of AMP for a different reason with kind of QBE leaving there? Hi, Nick, George here. So look, generally, we're seeing really good demand for space that we've got available. So we're confident around A And P Center, and retaining good occupancy there. And particularly that asset, on its price point, on location combined means it's quite attractive for a number of people. In terms of, other assets, the existing PwC tower, That space is largely leased. And we have some inquiry on the balance of space in ANZ Center. Yeah. No, that's cool. And then just one kind of semi random question. On your market outlooks for, say, Auckland, I noticed you've used JLR as the reference to kind of rental growth. And previously, it was CBA, Ari or Colliers. Is there a particular reason change there around relative outlook for research houses? No, is not really. It's sort of timing of work completed and we tend to rotate them a bit. Thank you. Your next question comes from Toni Sherlock from Morningstar. Please go ahead. Good morning guys. Just a few questions on leasing costs. I think that you indicated that the tax rate was going to be lower because there will be more leasing costs coming through. I'm just wondering if they've actually been outlaid or they're coming through in the second half? Hi, Tony. Yeah, no, there's an anticipation of additional lease fees in the second half, both in the investment portfolio, but also we're lessening at the retail and office within Commercial Bay, and also with the expectation that when you are 2nd stage would progress with the 50% at least, our pre commitment So what's the order of magnitude, just an indicative range of cost outlay that we should be thinking about? I think just look to the guidance of the 4% to 6%, Tony. Okay. No problem. Just I know you mentioned that there were some delays around the election. What are the major alternatives that these tenants are they looking at staying in their current building? Or I'm just wondering why if their lease is up, what's what are their major alternatives that they're considering? The state put. So you should be honest, Tony? Yeah, it's, I mean, there's you know, commercial based forty thousand meters. There's one other, what you might call CBD fringe based office building that's currently under construction, which is sort of 14,000, and there's a thirty or forty year old tower with 700 meter floor plates that's been refurbished, that's in the market. So they're really the options other than the existing, sort of market and all of the occupiers that we're talking to at stay put or relocate to commercial bay. Okay. That's fine. And I noticed that you and the underwriting was 4.7% and December 4.7%, has I probably was expecting that to blow out a bit further. Did mark do you see market rents actually not having moved or your, I just hold portfolio, just moving in line with that? I was just wondering if there was market specific stuff that impacted that? Tony, now it's more that, we're still comparing with the June valuations. We haven't updated valuations 31 December. Okay. All right. And just as a finger in the air view on that, do you feel that it's now moved out to 6% or still sitting around that five number? Yes, look, I commented, in the presentation, leasing that we've completed has, on average, been 1.8% above valuation rentals, so they're above the 30 June valuation rentals. So that indicates continued strength in the market. We'd see that also in market reviews completed. So for Auckland, probably, I would say, we're year on year, maybe up around sort of 4% level. And, Wellington with the supply impacts is probably more like around sort of 6% level. That's fine. Thank you very much. The final question, just on the smaller leases and suites, that you're indicating kind of maybe potentially trickling through, how does that impact your returns from feasibility given that the presumably the rent per square meters would be higher for those. Yeah. Generally, your cost to construct the suite is a little higher, and we would look to get a corresponding lift in rent to offset that, and keep whole in terms of our feasibility record level assumptions. So you'd say to wash then really with the CapEx impost? Yes, I mean, to be honest, what we had seen in the market and there's a couple of very good operators in the market that do do small leases, sorry, small suites really well. And I would say generally they're getting premiums to market rents. We're not assuming that in our feasibility yet. The extent to which we can obtain it would be, would be upselling. Okay. And I've not checked out the actual rents on generator versus commercial bay, just as an indicator, I know it's a different type market, but do they compete in some ways? Look, the generator offer would tend to tend to sort of be limited, to sort of 20 employees or less generally. There might be occasion when it's a little bit more. So there's not really a direct competition with the size of with the size of suites we would create at commercial Bay. Okay. All right. That's fine. Thank you very much. Thanks, Tony. Thanks, Annie. Thank you. There are no further questions at this time. I'll now hand back to Mr. Pritchard for closing remarks. Thanks, Denver. And look, I just want to thank everybody for dialing in once again and appreciate your support. Have a great day.