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Edited Transcript of AOF.AX earnings conference call or presentation 25-Aug-19 11:30pm GMT

Full Year 2019 Australian Unity Office Fund Earnings Call

SOUTH MELBOURNE Sep 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Australian Unity Office Fund earnings conference call or presentation Sunday, August 25, 2019 at 11:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mark Lumby

Australian Unity Office Fund - Fund Manager & Head of Commercial Property at Australian Unity Investment Real Estate Limited

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Australian Unity Office Fund annual results presentation conference call. (Operator Instructions) I would now like to hand the conference over to Mr. Mark Lumby, Fund Manager, AOF. Please go ahead.

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Mark Lumby, Australian Unity Office Fund - Fund Manager & Head of Commercial Property at Australian Unity Investment Real Estate Limited [2]

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Good morning, everyone, and welcome to the 2019 full year results announcement for the Australian Unity Office Fund. My name is Mark Lumby, and I'm AOF's Fund Manager.

Today, we'll discuss AOF's performance for the full year ended 30 June 2019, the outlook and guidance for FY '20, including the proposal from Abacus and Charter Hall Consortium and provide you with the opportunity to ask any questions you may have.

Earlier today, we published various documents on the ASX, including the annual financial report for the year ended 30 June 2019, Appendix 4E, our property book and the investor presentation, which we'll run through this morning. We anticipate this call will take around 20 minutes.

Before we start on Slide 2, it's important to note that the information in this presentation is general information only and should be read in conjunction with the annual financial report lodged with the ASX earlier today.

Starting on Slide 4. I'm pleased to report that we continue to deliver on the key fund objectives for investors of delivering sustainable income returns with the potential for capital growth over the long term. Since AOF listed on the ASX a little over 3 years ago, we have met or exceeded our earnings and distribution guidance each year. Net tangible assets per unit have increased by 42%, and we have delivered a total return to investors of 83% or approximately 21% per annum since listing the fund.

The management team remains committed to delivering on its key objectives with leasing a key focus. Over the last year, we have completed leasing deals of 11% of the portfolio by area, resulting in an increase in the overall occupancy to 95.3%. This is close to the high points since fund listed 3 years ago. This followed leasing activity, combined with the strong institutional investment demand and rental growth in metropolitan markets, drove a $32 million increase in AOF's total assets to $677 million, and increase NTA per unit by 4.5% to $2.79 per unit.

We've also made great progress with the planning requirements of the proposed Parramatta development. In the last few months, we've received a Gateway Determination from the New South Wales state government, completed the community consultation process and have completed the draft development application for a 28,000-square meter office building ready to be lodged with Parramatta Council this week. I'll discuss this proposed development in more detail later in the presentation.

Our capital management position remains conservative. Gearing has reduced slightly to 29.5% and our debt term is just over 3 years. Over the last 2 months, we've been working with the Consortium, comprising Abacus and Charter Hall, who's made a nonbinding indicative offer of $3.04 cash per unit. I'll offer talk to this in more detail soon.

Turning to Slide 6. And in the 12 months to 30 June 2019, the statutory net profit was $44.8 million, which is approximately half of the FY '18 result. The principal reason for the reduction in net profit was because the rate of growth in asset valuation was stronger in FY '18 compared to FY '19. To put this into context, the cap rate tightened 31 basis points last year, and in the prior financial year, the cap rate tightened approximately 100 basis points. I'll explain property valuations in more detail later in the presentation.

Moving on to FFO, this increased by $1.2 million to $28.2 million, mainly reflecting holding 150 Charlotte Street, Brisbane for the full year. FFO per unit increased by $0.001 per unit to $0.173 per unit, which was the midpoint of our guidance at the start of the year. Distributions increased by $0.002 per unit to $0.158 per unit. And net tangible assets per unit was $0.12 higher than 30 June 2018, reflecting higher portfolio valuations, offset a little by the mark-to-market value of interest rate swaps.

Turning to capital management on Slide 7. During the year, total borrowings increased by $6.5 million, which was used to fund capital expenditure and fit-out incentives. While borrowings increased, the higher property valuations resulted in the gearing decreasing slightly to 29.5%, well within our target gearing of below 40%.

There was no change to the debt facility limit of $220 million. However, during the year, we took out new interest rate swaps with a nominal value of $120 million. This resulted in a lower weighted average cost of debt this year of 3.7% per annum compared to 3.9% a year ago. The interest cover ratio reduced slightly to 4.57x reflecting the full impact of the revised capital structure following the 150 Charlotte Street acquisition. The interest rate remains well above the debt covenant of 2x.

Moving on to the portfolio highlights on Slide 9. We've had a good year leasing up vacant space, which has contributed to the portfolio occupancy increasing to 95.3% and have made further progress since 30 June with new leases or nonbinding heads of agreement across a further 2.1% of the portfolio.

Overall, AOF's earnings profile continues to be underpinned by high-quality tenants, including Telstra, the New South Wales and federal governments, Boeing and GE. These 5 investment-grade tenants account for over 60% of the portfolio's income. We've also made great progress with the planning requirements of the proposed development at 2 Valentine Avenue, Parramatta and have completed the draft development application for our 28,000-square meter office building ready to be lodged with Parramatta Council this week.

Looking at the leasing activity in more detail on Slide 10. A significant portion of the leasing occurred at 468 St Kilda Road, Melbourne, 2 Eden Park Drive in North Ryde and 241 Adelaide Street, Brisbane. While tenant demand is stronger in St Kilda Road, it's picking up in North Ryde following the opening of the Northwest rapid transit line in May. Tenant demand for speculative suites in Brisbane is also increasing.

Following recent leasing success, 468 St Kilda Road remains 100% occupied and 2 Eden Park Drive has also reached its milestone, with both assets continuing to experience good rental growth.

Market rents at 468 Kilda Road, for example, were $340 net per square meter 1 year ago. Now there are far -- I'm sorry, now they are $375 per square meter net, representing an increase of about 9% in the space over the year.

Overall, we struck leasing deals on 11.4% of the portfolio, comprising 9,000 square meters of completing leases across 30 different tenants and 3,200 square meters of leasing deals under a nonbinding heads of agreement.

In this mix, the market vacancy in Adelaide is starting to improve, which is evident by the leasing deals we've completed over parts of the top 2 floors and the sublease activity for some of Telstra's space at 30 Pirie Street.

We're also close to addressing some of the near-term lease expiries in FY '20. Despite some considerable focus on the due diligence for the Abacus and Charter Hall Consortium, since 30 June 2019, we have transacted on a further 2,200 square meters of signed leases or heads of agreement across 10 tenancies. Looking forward, AOF has a relatively favorable lease expiry profile with no significant single lease expiry until June 2022. Needless to say, leasing and increasing portfolio occupancy remains a key management focus.

Turning to valuations on Slide 11. All properties were revalued as at 30 June 2019, in line with our valuation policy and reflecting 2 items: the first, strong investment market conditions; and the second, the Independent Board Committee's request to revalue the entire portfolio in the context of the nonbinding indicative offer of $3.4 cash per unit from a Consortium comprising Abacus and Charter Hall.

Overall, the portfolio increased by nearly $33 million as a result of cap rate compression and market rental growth. Capitalization rates compressed by 31 basis points in line with the MSCI Index for this period.

Market rental growth also contributed to the strong capital increase, particularly in the Parramatta and St Kilda metropolitan offer markets, which have been some of the best-performing office markets for the few years. We've also experienced some modest rental growth in North Ryde off the back of the improved infrastructural in the area, in conjunction with the cheap rental profile compared to Sydney's CBD. North Ryde's rent is approximately 1/3 of that in the Sydney's CBD and has attracted tenants like Herbert Smith Freehills to the area.

Overall, the capital price -- sorry, the capital value of the portfolio is $6,200 per square meter, which still represents good value. While the value of the property at 10 Valentine Avenue increased by $5 million, this reflected market conditions for the existing property and tenancy. The $120 million valuation does not take into account any development potential associated with the proposed 28,000-square meter office building, which may have a significant impact on the valuation.

This leads me into Slide 12. You'd be aware that we're pursuing a development scheme for a commercial office building with net lettable area of approximately 28,000 square meters at 2 Valentine Avenue, Parramatta, which is on the same title as AOF's existing property at 10 Valentine Avenue. In April 2018, we received a development consent to build an office building of approximately 8,000 square meters. We are currently pursing a site-specific planning proposal to amend the building height and floors by ratio standards that apply to the site at 2 to 10 Valentine Avenue that would enable a larger office building to be developed of approximately 28,000 square meters.

On 29 May 2019, the New South Wales government Department of Planning and Environment has delegate for the Minister for Planning and Public Spaces determined that our site-specific planning proposal should proceed subject to the conditions of the Gateway Determination. The Gateway Determination is effectively an enabler to the development application.

The conditions of the Gateway Determination require the city of Parramatta Council to consult with the community and the relevant public authorities. The community consultation process finished on 2 August 2019 and a few minor submissions were received. Parramatta Council will review these submissions and determine if the local environmental plan should be made. This meeting has been scheduled for mid-October 2019.

Assuming that it results to proceed, the local environmental plan will be prepared by the New South Wales Parliamentary Counsel. With the minister's approval, the local environmental plan is published on the New South Wales legislation website and becomes law. The Gateway Determination states that the site-specific local environmental plan is to be finalized and gazetted by 29 February 2020. Although time frame to gazettal is uncertain, it might occur in '20 -- sorry, it might occur in December 2019 at the earliest.

The draft development application for a 28,000-square meter office building is complete and ready to be lodged with the city of Parramatta Council this week. This is another key milestone to delivering substantial value for unitholders. Once lodged, this will enable the assessment process to run in parallel with the site-specific gazettal process.

We are also continuing our efforts to seek leasing precommitments for the proposed development and are in discussions with a number of tenants. As announced previously, we're targeting a fully let yield on cost, including tenant incentives and finance cost of between 7% and 8%. The indicative value range of the completed new building is between $250 million and $300 million.

Turning to Slide 14. We received an unsolicited indicative and nonbinding proposal from an entity associated with Abacus Property Group and Charter Hall Group to acquire, by way of a trust scheme, all of the issued units in AOF that the Consortium does not already own for $3.04 cash per unit, reduced by any distribution announced or paid in respect to the scheme other than the $0.0395 per unit distribution announced on 21 June 2019.

The 4-week due diligence period ended on 13 August 2019. We have been finalizing the provision of outstanding due diligence information to the Consortium, including the recently completed development application and specific detail relating to the proposed development at 2 Valentine Avenue, Parramatta.

The Independent Board Committee established by our Board to consider the proposal, along with its investors, is finalizing terms of a Scheme Implementation Agreement with the Consortium in relation to the proposal.

Distributions will continue to be paid quarterly unless we enter into a Scheme Implementation Agreement with the Consortium in relation to the proposal, in which case, we may not proceed with payment of the distribution for the quarter ended 30 September 2019 or any subsequent quarter, given the consideration under the proposal would be reduced by this amount.

Any further developments in relation to the Scheme Implementation Agreement will be disclosed to the ASX in the ordinary clause. If the scheme is approved by AOF unitholders, all units in AOF will be sold to the Consortium and AOF will be delisted from the ASX.

In closing on Slide 16, we believe AOF is well placed to deliver on its objective of providing unitholders with sustainable income returns, with a portfolio underpinned by 95.3% occupancy, with no single significant lease expiry until June 2022 and nearly 60% of the portfolio leased to investment-grade tenants, such as Telstra, government, Boeing and GE.

To that end, subject to no material change in current market conditions and no unforeseen events, we provide AOF's FFO guidance for the 2020 financial year of between $0.173 and $0.177 per unit and distribution guidance of $0.16 per unit for the same period. This of course is based on operating AOF as business as usual.

If the Scheme Implementation Agreement is signed with Abacus and Charter Hall Consortium, then we may seize distributions until such time that unitholders vote on the proposal.

In the meantime, we will continue to focus on our key objectives, particularly as it relates to leasing any vacancies but also to further progress the potential significant proposed development at Parramatta.

I would like to thank you for providing us with the stewardship of your investment in AOF. We've delivered some exceptional results for investors over the last few years, which is summarized on Page 17, that the team and I are very proud of.

That concludes the formal part of the presentation.

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Operator [3]

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(Operator Instructions) There are no questions at this time. I'll hand back to Mr. Lumby for closing remarks.

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Mark Lumby, Australian Unity Office Fund - Fund Manager & Head of Commercial Property at Australian Unity Investment Real Estate Limited [4]

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Well, thank you, everyone, for your time today. That completes the presentation. We'll make this webcast and audio call available on our website, australianunityofficefund.com.au later today. Thank you and good morning.