Dexus Industria REIT

ASX:DXI

Earnings Call Analysis

Earnings Call Transcript 2024-Q4

[Operator]

Thank you for standing by, and welcome to the Dexus Industria REIT 2024 Annual Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Gordon Korkie, Fund Manager. Please go ahead.

[Gordon Korkie, executive]

Good morning. I'm Gordon Korkie, Fund Manager of Dexus Industria REIT. Thank you for joining us for the 2024 full year results presentation. I'd like to start proceedings by acknowledging the traditional custodians across the many lands on which we operate throughout Australia. We pay our respects to their elders, past and present, and remain committed to supporting reconciliation across our business. .

Today, I'll cover off on DXI's investment proposition and key highlights for the period, the financial outcomes as well as providing some color on portfolio performance and an overview of recent market dynamics that we are seeing. I'll then hand over to Q&A. We'll be joined by Chris Glasson, General Manager of Funds Finance.

The DXI investment proposition is to generate strong risk-adjusted returns for investors seeking listed industrial real estate exposure. We deliver this by generating organic income growth from a national well-located portfolio of high-quality assets that can reach 80% of the population within 60 minutes.

Secondly, we conservatively manage the balance sheet to provide resilience and the flexibility to invest opportunistically throughout the cycle. And thirdly, we've taken an active but disciplined approach to portfolio management. We leverage DEXUS capabilities across transactions, development, leasing and asset management to execute on these objectives.

Turning to the highlights for the period. I am pleased to confirm that we have delivered on our upgraded guidance with FFO per security of $0.174, up 1.7% on the prior year, reflecting our proven and long-standing active management approach and resilience of the portfolio to generate a growing income stream. The result was underpinned by strong portfolio like-for-like growth of 7.8%. Leasing momentum continued in the second half with Brisbane Technology Park now close to full occupancy. We also achieved re-leasing [ rates ] of 28.3% across our industrial leasing, which will support future growth. During the year, we divested $135 million of assets, which provides capacity to recycle capital into our development pipeline.

At our investment in Jandakot, which was rebranded to ASCEND during the year, we achieved an average 5.3% yield on cost across 2 projects leased to [ Milestone and Katy ]. Construction began at our last mile project in Moorebank with an initial lease secured at a record rent for the Southwest Sydney market. We retained balance sheet strength with look-through gearing remaining low, our 30% to 40% target range, which positions us well amidst the challenging economic environment but also provides us the flexibility to be opportunistic.

Turning to the fundamentals of our quality portfolio. The diversified portfolio comprises interest in 89 assets valued at $1.4 billion with 65% exposure to the East Coast. The portfolio provides an attractive and resilient income stream with the portfolio being close to full occupancy, a WALE of 5.9 years, backed by high-quality tenant covenants and an attractive mix of rental escalators with more than 50% of these linked to CPI, which provides strong defensive characteristics.

We continue to actively position the portfolio to generate long-term performance and capture growth in the industrial sector. This included forward leasing to reduce future aspire risk on the stabilized portfolio amidst the softening leasing environment and ahead of the delivery of new supply into the market, while also retaining a disciplined approach to investing into our development pipeline.

Turning to the [ tense ] mix. Our assets are leased to over 170 tenants across a well-diversified mix of sectors, which continue to perform well, including wholesale trade, construction, manufacturing and services. We have minimal exposure to third-party logistics operators, which have continued to withdraw and sublease space as growth continues to normalize, following the extraordinary levels of take-up experienced in recent years. Our top tenant is [ WesTrac ], representing 16% of total income with over 10 years remaining on the lease. [ West Track ] have continued to invest in the performance of the facility, including through large-scale on-site solar projects and automation. The remainder of our rent roll is leased to experienced national and global operators, including Amazon, Sandvik and Kmart to name a few.

Turning to sustainability. The DXI portfolio continues to maintain its carbon-neutral status, an outcome we largely achieved through our controlled assets, which has been supported by the installation of approximately 2.5 megawatts of solar across the portfolio. We continue to integrate sustainability into developments from both a design and a construction perspective.

And at Moorebank, we've been able to crush and reuse concrete with a goal to recycle 80% of construction waste.

Turning to the financials. We delivered FFO for the year in line with our upgraded guidance of $55.3 million or $0.174 per security. The result is reflective of the strong operating performance across our portfolio with like-for-like growth of 7.8% and 180 basis point improvement in portfolio occupancy. In addition, capital management initiatives were instrumental in helping offset the full impact of higher interest rates. Distributions for the year were $0.164 per security, reflecting a payout ratio of 94.1%. Net tangible assets per security reduced $0.20 to $3.24, mainly due to asset devaluations.

Turning to the balance sheet. Our look-through gearing remained low at 27.3%, and we are well positioned to consider value-enhancing capital deployment initiatives, including our development pipeline. Even if we were to fully debt fund our entire development pipeline today, our gearing would remain well below the top end of our 30% to 40% target range. We have repositioned our debt book during the year, with average debt maturity increasing to 3.5 years following $208 million of facility extensions, which were executed at lower margins to deliver future savings. We also retired $71 million of facilities to optimize headroom and reduce debt costs.

Turning to capital recycling. We were deliberate in disposing assets early in the devaluation cycle to unlock the attractive investment opportunities within our development pipeline. Over the past 2 years, we have divested close to $300 million of assets with over half of this relating to the divestment of [ Roads ] Corporate Park, which increased our portfolio [ adding ] to industrial by [ 10 cents ] to 89% today. Through repaying debt, we have afforded ourselves the ability to redeploy capital while withstanding the impact of continued devaluation pressure without any distress. We completed almost 44,000 square meters of developments at Ascend at Jandakot across 3 projects, 2 of which completed in July 2023. The fully leased projects were delivered at an average yield on cost of [ 5.2% ] compared to the [ $0.44 pass ] yield on the assets we divested to fund these.

Looking forward, we will continue to remain disciplined when deploying into our development pipeline by targeting yields on costs, inclusive of capitalized interest of 6.25% and above. Given the development land is already paid for and fully expensed on our P&L, we can achieve incremental returns of 8% and above, which remains comfortably above our marginal cost of debt and is accretive to earnings.

Turning to valuations. During the year, we independently revalued 100% of the portfolio. On a like-for-like basis, property valuations declined $66.3 million or 4.6% on prior book values, with a weighted average cap rate expanding by [ 50 ] basis points to approximately 6%. Rental growth outcomes across the portfolio continue to support valuations and partly offset cap rate softening.

Turning to portfolio performance. Our investment portfolio delivered strong operating performance and accounts for 89% of total assets. Like-for-like growth was 6.3%, supported by 4.5% average rent reviews and double-digit re-leasing spreads achieved in FY '23. Amidst the softening leasing environment and ahead of new supply being delivered, we continue to actively manage expiry risks, having forward leased 36,000 square meters while also capturing strong reversionary upside. During FY '24, total leasing of approximately 72,000 square meters was undertaken, achieving a 15.7% re-leasing spread. The majority of the leasing was undertaken in the second half at a spread of 28.3%.

Turning to ASCEND at Jandakot. The estate continues to perform well and delivered like-for-like growth of 4%, which was impacted by lower occupancy following the early departure of a tenant at 631 Karl Avenue as disclosed at the half. Importantly, the departure culminated in a surrender payment equivalent to gross lease tail. And pleasingly, the asset is now 65% leased with active inquiry in the balance.

Turning to asset management. We delivered strong leasing outcomes at a number of assets, including at one of our largest, 2 Maker Place at Truganina in Melbourne, where we negotiated an early tenant departure originally due for FY '26 to unlock a 42% re-leasing spread across over 30,000 square meters. In Adelaide, we renewed or released units across all 4 assets with no downtime. While average re-leasing spread was small at 2%, it is noteworthy that leasing embeds the strong over-rented deals these assets were acquired on with new rents struck 11% above valuation assumptions.

Turning to developments. The total cost of the development pipeline is $250 million across more than 300,000 square meters with projects in Sydney and Perth. Across our committed projects, we have $23 million of remaining spend. Included within this amount is our last mile logistics project in Moorebank, located in one of Sydney's strongest infill submarkets and expected to deliver at an attractive yield on cost ranging between 6% and 6.5%. We estimate a further $140 million of capital will be required to build out the land holdings at ASCEND in Jandakot, where we are targeting yield on cost of 6.25% and above. DXI is well positioned to fund these developments within the constraints of the target gearing range.

Turning to market dynamics. The long-term thematic for the industrial sector remains supportive, driven by population growth, which is expected to grow at 1% per annum over the next 40 years, which is one of the highest rates amongst advanced nations. The structural shift towards e-commerce is also expected to continue with online penetration rates expected to increase 3.5% per annum to 2030. Together, population growth and e-commerce are expected to generate incremental demand of between 2.3 million and 2.6 million square meters annually. In the near term, we expect demand from nondiscretionary segments to hold stronger, while the third-party logistics sector is expected to remain subdued. Overall, demand continues to outpace new supply given the lack of immediately available service land and construction cost pressures. In 2024, uncommitted available supply remains 1 million square meters below the average take-up levels for the 5 years pre COVID. New supply will likely be held in check given the high economic rents to unlock new opportunities driven primarily by the resilience in land values and high construction costs. This bodes well for continued rental growth, albeit at lower levels compared to recent times.

Turning to BTP. We delivered exceptionally strong performance with like-for-like growth of 16%. We leased over 1/3 of the park, which supported a 12 percentage point increase in occupancy to 98.1%, which continued the improvement we saw in the first half. Demand was broad-based, reflecting BTP's relative to value proposition, offering rents almost half of that within the Brisbane CBD office market. Leasing was executed at positive re-leasing spreads of 3% and were struck 6% above value and market assumptions, while incentives remain approximately 20 percentage points lower than the Brisbane CBD ops market.

As in past periods, we have continued to achieve strong retention levels with 73% of the space retained or backfilled within 3 months. These factors continue to support a very attractive income yield of almost 8%.

Turning to the outlook. We are well placed to continue delivering long-term value for investors. We remain focused on enhancing our portfolio to drive organic income growth, diligently pursuing value-enhancing investment opportunities, all while ensuring that we maintain a strong capital position. Our earnings profile is resilient, and our balance sheet provides great flexibility to perform well, regardless of the economic environment.

FY '25 guidance is for FFO per security of $0.178, reflecting growth of 2.3% on the prior year, and distributions of $0.164, which reflects a distribution yield of approximately 6% for our investors. Thank you for joining the call. I'll now hand back to the moderator for questions.

[Operator]

[Operator Instructions] Your first question comes from David Pobucky from Macquarie Group. .

[David Pobucky, analyst]

Congratulations on the strong results. Just first question around BTP. I think previously, it was spoken about divesting that asset at some point in time. But given the improved occupancy at the asset, how are you thinking about that on a go-forward basis? And have you been applying capital partners interested in the asset? .

[Gordon Korkie, executive]

Look, obviously, the asset is performing exceptionally well, throwing off a pretty strong yield close to 8% for us at the moment. In terms of our view, look, it hasn't really changed. Our focus though does shift making sure that we can optimize the opportunity, the longer-term opportunity. I'm sure that we get a pretty good price on that in due course. So there's a question around timing. .

In terms of offers, we have been numerous times on that asset, as you always do on a range of assets. There is 1 party we are discussing 1 of the assets on. But look, it's early days. There's some optimism in some of the discussions that we are having, but I don't think I can really discuss it any more broader than that at this point in time.

[David Pobucky, analyst]

That's clear. Appreciate it. On the balance sheet gearing, it's at 27%, so that provides runway for deployment. Are there any acquisitions that have come across your desk that are of interest? Or is that something that you'd be looking to pursue? .

[Gordon Korkie, executive]

Well, we're always looking at opportunities within the market. I think it's fair to say that we've got a pretty reasonable development pipeline that at the moment is just throwing off much more attractive return parameters for the fund. That's where our focus is. We'll continue looking at the opportunities within the market. And it's fair to say that at some point, we'll hopefully be active on the East Coast. .

[David Pobucky, analyst]

And just one last final one, just on the development opportunities. You're targeting a yield on cost on future developments of 6.25% plus. I think that compares to circa 6% at the first half result. Is there anything to kind of read into that? .

[Gordon Korkie, executive]

Not really. We've seen cap rates at Jandakot increase by 50 basis points over the last year. So it was really making sure that we preserve the risk-adjusted returns on the developments moving forward. And that's really the extent of it. I think we still remain pretty excited that we can achieve yield on costs inclusive of capitalized interest north of those levels.

[Operator]

The next question is from Andy McFarlane from Bell Potter.

[Unknown Analyst]

Just a couple of quick ones for me. Just in terms of the EPS guide. Just wondering, you've obviously -- you're reflecting a bit of growth into '25 for the earnings, but you're holding distribution flat. Just wondering kind of what thinking there is. .

[Gordon Korkie, executive]

Andy, well, I guess, in the last couple of years, we've seen our payout ratio tracking a little bit higher than where we've historically been. That was really on the back of the transformative acquisition at Jandakot as well as, I guess, a very large increase in interest costs over the last few years that we've had to absorb. So holding guidance is really reflective of trying to return more to a historical payout ratio, where we're looking in and around the [ 90% ] mark. .

When we look at where our projected earnings is relative to where we need to be to start looking to increase distributions, we only need growth of 2.2%, and I think that's within striking distance. So hopefully, we can look to grow our distributions in periods to come.

[Unknown Analyst]

I think just one other thing on the guidance, just in terms of what you're assuming on variable debt component within guidance for FY '20?

[Gordon Korkie, executive]

Yes, sure. So at the time that we were setting guidance, we had regard to where the market was pricing, which was in the mid-4s at that point in time. We've chosen to hold our levels, just given the volatility we've -- in the past, we've seen volatility where rates have moved around. This is not the first time we've seen a retraction in rates only to revert. So we remain comfortable with that assumption. Where that leaves us is a all-in rates in the mid-4s. So you'd be expecting to see roughly a 75 basis point expansion across or relative to FY '24.

[Unknown Analyst]

For the [ WACD ]. .

[Gordon Korkie, executive]

That's right.

[Unknown Analyst]

Last one, just on -- I guess, on that, your actives still pretty low. It's obviously seen the benefit of some good hedging in the past, hedging looks to be rolling a little bit. Just wondering how you're thinking about your hedging as we kind of go forward. .

[Gordon Korkie, executive]

Well, I mean, 4.5%, let's say, in FY '25, I don't know if that's necessarily low. I think that's aligned with many in the market. We're not probably the only REIT in the sector to be faced with hedge books that are rolling off lower rates. In terms of our outlook, look, we've got very comfortable levels of hedging. We've got roughly 65% and above in FY '25 and remain well placed in '26 as well. So we don't have to go into the market to do any incremental hedging at this point in time. But we'll continue looking at the opportunities based on the curve and make the appropriate calls at the appropriate time. .

[Operator]

The next question is from James Druce from CLSA. .

[James Druce, analyst]

Just wanted to get a feel for the like-for-like guidance for NPI for '25.

[Gordon Korkie, executive]

Sure, james. Well, look, for the period at hand, we obviously delivered a number of 7.8% as reported. Looking forward, we probably expect that to be more on the mid-4s. And really, the -- I guess, the drivers of that is a much lower inflation print that we're expecting in '25 in the prior period. That was circa 5%, where it's more likely to be 3.5% in the year ahead.

We're also seeing probably a smaller contribution from the lease-up of vacancy come through in the next period. And then we've got 3 months of downtime to make a place, which is one of the important leasing deals we talked to as part of the results.

[James Druce, analyst]

Okay. So just putting that math together, you're growing at 4.5%. That's roughly $3.5 million of extra income coming through your hedging ex what happens with the floating is plus [ $0.5 million ] .

[Gordon Korkie, executive]

Sorry, my apologies. I thought you were talking specifically in relation to MPI. You're talking more akin to the upgraded guidance? Is that correct? .

[James Druce, analyst]

Yes. So just looking to the outlook for '25, really. .

[Gordon Korkie, executive]

Yes, correct. But at a fund level. So let me maybe set back. So the property FFO growth will be approximately 4.5%. I've spoken through the key drivers as part of that, then we'll -- so overall, that 4.5% will contribute roughly to a 7% increase in terms of contribution to FY '25 growth. There will be a drag of approximately 5% coming through the financing lines based on the 75 basis point expansion in your all-in cost debt that I previously called out. And then there's a residual 0.5% contribution mainly from developments coming through in FY '25. .

[James Druce, analyst]

Okay. So if you take out -- on my rough numbers, if you strip out the floating assumption that you've made and just look at the hedged increase, the increase in hedge rate over the period, plus your like-for-like NPI growth, it should be closer to 4% growth for '25. Is there anything else to call out there? .

[Gordon Korkie, executive]

Well, look, it really probably depend on what your development leasing assumptions are. We have taken, I guess, a conservative view given some of the thematics playing out as far as that's concerned. The 2 key leasing exposures are Jandakot at Moorebank. Firstly, as far as Jandakot is concerned. I mentioned that we're in advanced discussions with tenants there. The commencement date remains unknown, but we remain, I think, well placed on that.

But just given the size of category, some of those leasing decisions can take longer. And so we've assumed a February '25 commencement. As far as Moorebank is concerned, the PC date is December, which intersects with the Christmas period, which is traditionally a slow period of time as far as leasing is concerned. And on the back of that, we've assumed one quarter of contribution in FY '25. So I think maybe once you adjust those, hopefully, you get to a number more akin to what you're expecting.

[Operator]

The next question is from Murray Connellan from Moelis Australia. .

[Murray Connellan, analyst]

Quite good results on the releasing spreads in the industrial portfolio. I was wondering whether you might have a comment on your expectations on the outlook there. Is that sort of reflective of where you see the average balance of the portfolio relative to market? Or maybe we can place this in the context of what your views are on under-renting versus market rents? .

[Gordon Korkie, executive]

Yes. So look, I think as past periods, we've always talked to our market. Our portfolio is being broadly market rented with the industrials being slightly over-rented -- sorry, under entered and the BTP portfolio being slightly over-rented. Look, we still see a good opportunity to continue to drive rents despite that. We've got a track record of outperforming value options. And when you look at the industrial portfolio, there's a mix of tenancies that are over-rented, largely on the back of specialization. So those tenants generally have a high value in use. The economic rents to replace that type of operation is much higher than the assumptions that valuers have adopted within our valuations.

So look, we remain well placed, I think, to maintain, if not grow that part of the book. And then by definition, given that overheated component, that means there's a component of the portfolio that's under rented. And so I think it remains a really strong ability to continue growing rents in the years ahead.

[Operator]

The next question is from Adam Calvet from CLSA. .

[Unknown Analyst]

You positive on the supply and demand from the industrial market. On Slide 16, you've actually pushed some of your uncommitted developments, which I assume is in Jandakot into FY '26. What's been the reason for that?

[Gordon Korkie, executive]

Look, Adam, there's no real science to it. Look, I guess we provide that time line as a guide only. We're not necessarily committed to deploying X dollars in X number of years. What's important to us is to ensure that we're getting good outcomes and capturing the right level of value out of those developments. So it probably aligns with a historical run rate. But as I mentioned, we're not really committing to delivering X dollars in any given year. It's all about making sure that we get the right return profiles from that development plan. .

[Unknown Analyst]

. And maybe just back to David's question on the increased yield on costs. So not only have you increased just the targeted yield on cost for new developments. It also increased Jandakot cost of 6% to 6.5%. Just trying to understand how -- what were the drivers for that increase? .

[Gordon Korkie, executive]

I thought I answered it previously, but largely on the back of a 50 basis point increase in cap rates over the last year. We've also had a look at where the incremental cost of debt is at the point that we set that target. I think a combination of those 2 factors meant that we arrived at that number. So look, I think what it does demonstrate is ongoing momentum in terms of the return profile that we can get out of Jandakot as well as Moorebank. .

[Unknown Analyst]

Sorry, just have construction costs decreased or market rents going up? I'm just trying to understand the real drivers of that.

[Gordon Korkie, executive]

Well, we're probably seeing an increase in market rates in Jandakot. The construction costs would be broadly stable at this point in time, I would say, with different factors influencing that. Concrete and steel probably a little bit softer than where it's historically been, but that's being offset by labor. .

[Unknown Analyst]

Great. And maybe just 1 more, if I may. Just on the tight margin, how much in terms of the cost of debt? How much tighter have you been able to achieve? .

[Gordon Korkie, executive]

Yes, relative to the historical facilities, we achieved roughly a 20 basis point savings. I don't think that necessarily represents the saving. Moving forward, we have been having discussions with many of our lenders who like what we're doing, and we have seen our expectation of market come in maybe half of the number I just quoted .

[Operator]

There are no further questions at this time. I'll now hand back to Mr. Korkie for closing remarks. .

[Gordon Korkie, executive]

Thank you all for joining the call. I look forward to connecting with you in the coming weeks. .

[Operator]

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect. .