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Edited Transcript of SCP.AX earnings conference call or presentation 3-Feb-20 11:00pm GMT

Half Year 2020 Shopping Centres Australasia Property Group Re Ltd Earnings Presentation

Feb 10, 2020 (Thomson StreetEvents) -- Edited Transcript of Shopping Centres Australasia Property Group Re Ltd earnings conference call or presentation Monday, February 3, 2020 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Michael Grainger Mellowes

Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited

* Mark James Fleming

Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited

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Conference Call Participants

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* Adrian Dark

Citigroup Inc, Research Division - Director and Analyst

* Andrew Dodds

Jefferies LLC, Research Division - Equity Analyst

* Edward Day

Moelis Australia Securities Pty Ltd, Research Division - Research Analyst

* Simon Chan

Morgan Stanley, Research Division - VP & Equity Analyst

* Stuart McLean

Macquarie Research - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Shopping Centres Australasia Half Year '20 Results Investor Briefing. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Mr. Anthony Mellowes, Chief Executive Officer of Shopping Centres Australasia. Thank you, sir. Please go ahead.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [2]

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Thanks very much for that, and welcome to our first half FY '20 financial results for the SCA Property Group. My name is Anthony Mellowes, I'm Chief Executive Officer. And presenting these results with me today is Mark Fleming, our Chief Financial Officer. Also in the room with me is Campbell Aitken, our Chief Investment Officer; Michelle Tierney, our Chief Operating Officer; and Mark Lamb, our Company Secretary and General Counsel.

Again, I'm pleased that this set of results reaffirms that we continue to remain true to our core strategy of investing in and managing convenience by centers weighted to the nondiscretionary retail area -- sector.

Firstly, let me take you to Slide 4 which sets out our first half highlights. Our funds from operations of $78.5 million is up by 19.1%, and our FFO per unit is up by 4.2%. And our distribution of $0.075 per unit is up by 3.4% all over the same period last year. Our gearing at 31 December was 34.2%. But after our January 20 DRP and the sale of Cowes and the return of capital from SURF 1, our gearing is now at 32.8%. Our NTA has increased marginally to $2.29 per unit, and our portfolio weighted average cap rate has remained fairly static at 6.46%. Convenience-based assets are still in strong demand for investors, particularly high net worth individuals or families, as investors continue to seek long-term defensive cash flows in this low interest rate environment. Our weighted average cost of debt has improved to 3.4%, with 5.6 years' weighted average debt maturity. Our portfolio occupancy is at 98.3%, and our specialty vacancy has improved to 4.8%, which again is within our targeted range of 3% to 5%. We also acquired $78.4 million of assets during the period.

Slide 5 sets out some of the key achievements that continue to demonstrate how we deliver on our strategy. With respect to the core business, our tenants are performing well. Our supermarket and discount department store MAT sales growth has continued to improve over the last 6 months, and turnover rental growth is also increasing. Our specialty moving annual turnover sales growth has also improved, with sales productivity increasing. Our specialty vacancy has reduced, and our occupancy costs, specialty occupancy costs, is now sitting below 10% at 9.8%.

Against a backdrop of softening in the broader retail market, our strategy has continued to be: to improve our tenancy mix with a bias towards the nondiscretionary retail categories; maintain high retention rates on our renewals; and reduce our specialty vacancy by focusing on difficult long-term vacancies. This strategy will ensure that we have sustainable tenants paying sustainable rents and ultimately support our strategy of generating defensive, resilient cash flows to support secure and growing long-term distributions to our unitholders.

In the last 6 months, while average leasing spreads were slightly negative and our average incentives were higher, we have achieved a sustainable improvement in occupancy and tenancy mix across the portfolio.

With respect to growth opportunities, during December 2019, we acquired Warner Marketplace in Northern Brisbane in Queensland, which is anchored by a Woolworths and an ALDI for $78.4 million. We also settled on Shell Cove Stage 3 development for $4.8 million, and we also agreed to sell Cowes in Phillip Island, Victoria for $21.5 million, which was 10% above our June 2019 book value.

With respect to SURF 1, we also sold all 5 properties for $69.3 million, which was 1.3% above the June '19 book value. And the majority of proceeds have already been distributed to all of our unitholders, including ourselves.

With respect to capital management, our balance sheet remains in a very robust position. As mentioned earlier, our gearing at 31 December was 34.2%, which is within our targeted range of 30% to 40%. However, taking into account the sale of Cowes, return of capital of SURF 1 and the January DRP, we're now at 32.8%.

Our weighted average cost of debt is 3.4%, and the term to maturity is 5.6 years, with 65% of our debt either fixed or hedged. And we currently have cash and undrawn facilities of nearly $146 million.

Finally, our funds from operation per unit grew by 4.2%, and our distribution of $0.075 per unit grew by 3.4%, all over the same period last year. Distributions have continued to grow every half year since FY '14.

I'd now like to hand over to Mark to present the financial results.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [3]

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Thank you, Anthony, and good morning, everyone.

I'll start on Slide 7, profit and loss. Our statutory net profit after tax was $90.2 million, an increase of 129.5% compared to the same period last year. There are 2 main reasons for this increase. Firstly, we've completed a number of acquisitions over the last 18 months that have increased our earnings. In particular, in the current half year, we received a full period contribution from the assets we acquired from Vicinity in October 2018 compared to only a part period contribution in the same period last year. As a result, net operating income was up by 17.1% to $101.5 million.

Secondly, we had an increase in the fair value of investment properties in this half year compared to a decrease in the same period last year, which was due to the expensing of transaction costs, particularly stamp duty, associated with the acquisitions completed during that prior period.

Comparable NOI growth is expected to remain at 1.6% for the full year and takes into account the execution of our strategies in a softer retail market. Corporate costs have increased primarily due to market-wide increase in directors' and officers' insurance premiums. And interest expense is relatively stable between the 2 periods, with higher average debt drawn, offset by lower cost of debt. Our cost of debt is now down to 3.4%, primarily due to the decrease in market interest rates.

So turning now to Slide 8, funds from operations. This slide sets out the adjustments that are made to the statutory net profit after tax to determine our underlying cash earnings numbers. To get to funds from operations or FFO, we reversed out the noncash and one-off components of our net profit after tax, including fair value adjustments. FFO of $78.5 million is up by 19.1% on the same period last year, and earnings per units are up by 4.2% to $0.0844 per unit. The primary drivers of this increase are comparable NOI growth, acquisitions and lower weighted average cost of debt. Adjusted FFO or AFFO includes deductions for capital items, being maintenance CapEx, leasing costs and fitout incentives. Maintenance CapEx was $1.9 million, slightly below the same period last year. However, leasing costs and fitout incentives of $6.5 million is higher than the same period last year.

The main reason for the increase in the leasing costs and fitout incentives is that we've completed a substantially higher number of deals than in previous periods. And consistent with our strategy, many of those deals have been on difficult long-term vacancies where higher incentives were paid. If we adjust for those difficult deals on long-term vacancies, our fitout incentives are much more similar to previous periods.

Our AFFO was $70.1 million, an increase of 15.7% on the same period last year. And our distribution of $0.075 per unit is an increase of 3.4% on the same period last year. In dollar terms, the distributions were $69.9 million, which is less than 100% of AFFO.

Moving now to Slide 9, which shows our summary balance sheet. The book value of our investment properties is $3.23 billion, an increase of $85 million or 2.7% since June 2019. The key drivers of this increase were the acquisition of Warner Marketplace for $78.4 million and the valuation uplifts on like-for-like properties, partially offset by the sale of the Cowes shopping center. Notably, the like-for-like valuation uplifts included a $17.8 million increase in the valuation of the properties we acquired from Vicinity in October 2018. Those properties were acquired for $573 million and are now valued at $594 million, an increase of 3.7%.

Our portfolio weighted average capitalization rate is now 6.46%, a slight tightening from 6.48% as at June 30, 2019. Net tangible assets per unit increased by $0.02 per unit to $2.29, primarily due to the investment property valuation uplifts. Our MER ratio has increased slightly to 39 basis points due to an increase in corporate costs, driven by the increased premiums on directors' and officers' insurance policies.

Turning now to Slide 10, which deals with debt and capital management. Our gearing is 34.2%, within our 30% to 40% target band. It's our preference for gearing to be below 35% at this point in the property investment cycle, and gearing is 32.8% when adjusted for the DRP underwrite, the SURF 1 capital return and the completion of the sale of Cowes, all of which have now settled after balance date.

Our weighted average cost of debt has now decreased to 3.4%, primarily due to the lower bank bill swap rate. Our weighted average debt maturity is over 5 years. 65% of our drawn debt is fixed or hedged, we had $145 million of headroom in cash and undrawn facilities and we're well within our banking covenants.

Looking forward, our next debt expiry is the Australian dollar medium-term note that expires in April 2021, and we'll provide a further update on our strategy for that expiry with our full year results in August.

Thank you. And I'll now hand back to Anthony for the operational performance overview.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [4]

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Great. Thanks, Mark.

Now turning to Slide 12, our portfolio overview. As mentioned earlier, during the 6-month period, we acquired Warner Marketplace and also the additional development sites at Shell Cove. We're focused on ensuring that our weighting of categories continue to be within the nondiscretionary sectors, being food, medical and retail services. Our occupancy at 98.3% -- is at 98.3%, and the number of our specialties has increased to over 1,800 tenants. 48% of our gross rent comes from majors such as Woolworths, Coles, ALDI or Wesfarmers, and of the other 52%, there remains a heavy weighting towards those key nondiscretionary categories.

Slide 13 describes our portfolio occupancy. As I said before, it continued to be maintained at 98.3%. But most importantly, our specialty vacancies reduced to 4.8% from 5.3% at June, which is within our range of 3% to 5%. Our specialty tenant on holdover for our entire portfolio is 0.9%, which is a slight improvement from June. And we have 3 major leases expiring in 2020, being the Coles -- Coles at The Markets in Brisbane, and they have just exercised 2 of their 5-year options. And both Coles and Kmart at West End Albury are also close to being -- finalizing their new leases with us.

Slide 14, sales growth and turnover rent. Our centers continue to perform well. The numbers on the slides includes all of our assets in the portfolio. Slide 31 in the appendix shows the breakup of those acquisitions in the core portfolio that we've previously shown. Our supermarket's MAT sales growth has increased to 2.6%, with both Woolworths and Coles showing positive growth.

Our Discount Department Store MAT sales growth has increased to 3.4%, with Big W's performance being particularly encouraging. Our specialty sales is still healthy at 2.3%, with our core categories continuing to perform well, being food and liquor at 2.7%, pharmacy at 3% and retail services relatively stable around that 5%. We continue to see stronger performance from our neighborhood centers at 2.8% versus our slightly larger subregional centers at 1.5%. Our turnover rent continues to increase. We now have 34 anchors or nearly 30% of our portfolio anchors contributing turnover rent, with a further 14 supermarkets within 10% of turnover threshold. Three anchor tenant turnover rents crystallized into base rent during the period.

Specialty key metrics are outlined on Slide 15. There are strong metrics for our specialty tenants, with sales growth increasing to 2.3% from 1.8% at June. Our sales productivity has increased to $8,134 from $8,010 at June. Our rents remain the lowest in the sector at $772 per square meter. And our occupancy cost has reduced slightly to below 10% at 9.8%, which is down from 10.1% at June.

Against a backdrop of softening in the broader retail market, our strategy has been to maintain a high retention rate on our renewals, which is up to 78% for the 6 months to December compared to 77% for the 12 months to June. We've reduced our specialty vacancy by doing a significantly increased volume of deals, particularly on difficult long-term vacancies. We've done 86 new deals in 6 months to December versus 87 for the 12 months to June. And again, we've been remixing towards those key nondiscretionary categories.

While average leasing spreads were negative and average incentives were higher, we have achieved a sustainable improvement in occupancy and tenancy mix across the portfolio. We are still maintaining our 3% to 4% annual fixed increases for 85% of our specialty tenants, and we remain on track to achieve our FY '20 comparable net income growth of 1.6%, as Mark mentioned earlier.

In summary, it's been our deliberate strategy to focus on sustainable cash generation. This is demonstrated by the increased number of new deals being 86 in the 6 months to December versus 87 for the entire 12 months to June. This has reduced our specialty vacancy from 5.3% to 4.8%. Within those 86 deals were 20 difficult long-term vacancies. If we adjust for these deals, the new lease spreads for the remaining 66 deals are basically flat, and our average incentives are 13 months, which is similar to prior periods.

Slide 17 talks about our assets and development. As we mentioned earlier, Warner Marketplace in Northern Brisbane was acquired in December for $78.4 million, representing a 5.92% implied fully let yield. It's anchored by both a Woolworths and an ALDI with 37 shops and some pad sites and also some development opportunity.

We also completed the acquisition of Stage 3 Shellharbour from Frasers Property Group for $4.8 million. This will form part of the entire Shell Cove neighborhood center. We also contracted to sell Cowes marketplace for $21.5 million, which represented a 10% premium to our June '19 book value, and this property has now settled.

Turning to Slide 18, had this slide for a while, which highlights the fragmented ownership in the sector, which continues to provide us with further acquisition opportunities. We are the -- SCP is the largest owner by number of convenience-based centers, and we will continue to look to consolidate this sector by utilizing our funding and management capability to execute on accretive acquisition opportunities. Since listing in 2012, we acquired 50 neighborhood centers for in excess of $1.7 billion in aggregate, and we've also divested 31 centers for over $500 million.

During this last 6 months, there were 17 neighborhoods and 1 subregional center that were transacted. And as we mentioned, we acquired 10%, which is the Warner Marketplace. We will continue to remain disciplined with respect to acquisitions and disposals, and we will transact where we believe that the relevant asset will add value to our unitholders.

With respect to our development pipeline on Slide 19, again, most of our developments are small, and we've identified and are working on 31 potential developments with total CapEx spend in excess of $115 million over the next 5 years.

Turning to Slide 20. Our retail funds management business, as previously forecast, this business has the potential to deliver some additional earnings growth for us in the future. Our first fund, SURF 1 was launched in October 15, and we have now successfully sold the 5 assets, which was consistent with the 5-year term set out in the original PDS. We achieved a sale price for the 5 assets of $69.3 million versus an original cost of $60.9 million. And our IRR is expected to be in excess of 10%, which will mean a performance fee will be realized to SCP once all the proceeds are distributed to the unitholders. We expect the windup process to complete it during calendar year 2020. Our SURF 1 and SURF 3 funds are performing in line with the expectations.

At this stage, there are no new funds forecast for FY '20. However, we will continue to monitor the retail and institutional market appetite for new product later in -- in later years.

Subject to our market conditions, the funds management business will continue to allow SCP to recycle some noncore assets and utilize our expertise and platform to earn some management fees in the future.

Slide 21, I'd like to talk about our priorities and outlook. Our core strategy, as outlined on Slide 22, remains unchanged. We will continue to seek and deliver our defensive, resilient cash flows to support secure distributions. We will focus on convenience-based retail centers with that strong weighting to the nondiscretionary retail segment, and we are seeking long-term leases to quality anchor tenants such as Woolworths, Coles, ALDI and Wesfarmers, which is, again, demonstrated by our latest acquisition.

We will continue to explore core business growth opportunities, as demonstrated with our development pipeline. But we will remain disciplined with respect to both acquisitions and disposal opportunities that only meet our investment criteria.

Slide 23 outlines sustainability. We remain on track to deliver on our sustainability targets with dedicated resourcing and focus on the 3 pillars of our strategy being stronger communities. We're planning on delivery of our commitment to roll out a stronger communities campaign against all of our centers in FY '20. Environmentally efficient centers. We are setting up a specific sustainability development CapEx project to drive investment in sustainability initiatives that generate acceptable returns. We have solar panels operational across 5 centers and expansion in capacity of renewable energy for both of our centers and our tenants.

We've got an installation of a further 2 building automation systems for management of air conditioning, lighting and energy demand. And we've got ongoing discussions and trials for the on-site processing of food organic waste and exploring how we can efficiently implement waste diversion practices across the portfolio for specialty tenants and common mall area waste.

With respect to responsible investment, the creation of our capital investment fund targeting these initiatives have achieved the greatest ESG outcomes and returns, and our climate risk assessment across the entire portfolio is underway.

I'd now like to turn it back to Mark to outline our earnings growth trends on Slide 24.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [5]

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Thanks, Anthony.

Slide 24 sets out our medium- to longer-term growth targets, which we include to help investors and analysts forecast our future earnings growth.

While our renewal and new leasing spreads for specialty tenants were lower in the last half year than they have been in the past, we are still generating rental growth from anchor tenant turnover rent and the specialty fixed annual increases of 3% to 4% per annum that are built into most of our specialty leases. We also believe that we can continue to make selected acquisitions of convenience-based shopping centers that meet our investment criteria. So while there will be variations from year-to-year, over the medium to longer term, we still expect to achieve FFO growth of between 2% and 4% per annum through a combination of rental uplifts, expense control and growth initiatives. Our current guidance for FY '20 FFO is $0.169 per unit, representing growth of 3.5%, which is comfortably within this range.

Anthony, back to you.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [6]

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Thanks again, Mark.

So turning to Slide 25, our key priorities and outlook. We truly continue to deliver on our strategy for FY '20. We're still focused on the integration of our acquisitions, with particular focus on continued remixing strategies for both centers. And our leasing is focused on sustainable tenants on sustainable rents. We want to maintain high retention rates on our renewals and really focus on reducing our specialty vacancy. We will continue to focus on managing expenses at both the center and corporate level while maintaining the appropriate standards. We continue to explore and acquire accretive neighborhood centers in disciplined and measured way, and we will also progress our identified development opportunities.

With respect to capital management, we'll continue to actively manage our balance sheet to maintain our diversified funding sources with long weighted average debt expiries and a low cost of capital, which is consistent with our risk profile. Our gearing is to remain below 35% at this point in the cycle.

Our earnings guidance has increased to $0.169 per unit, and our distribution guidance is maintained at $0.151 per unit, which is 3.5% and 2.7% above our FY '19 actuals, respectively.

In conclusion, I'd like to say that we continue to consistently deliver on our clearly stated strategy and objectives. We'll continue to optimize our core business. Our occupancy has continued to reach its sustainable range, and we're focused on improving our tenancy mix, particularly with our recent acquisitions and maximizing our lease renewals, albeit at sustainable levels.

We've built solid foundations to enable us to continue to seek out and execute on our identified growth opportunities that are consistent with our strategy and profile.

I'd now like to invite any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from the line of Andrew Dodds from Jefferies.

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Andrew Dodds, Jefferies LLC, Research Division - Equity Analyst [2]

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Just firstly on the upgrade to FY '20 guidance. I was just hoping to maybe quantify some of the main drivers behind that, particularly given you're still forecasting comp NOI growth of about 1.6%.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [3]

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Yes, sure, Andrew, I'll take that, Mark here. The main drivers are set out on Slide 28. So just to go through that in a bit more detail, the biggest single contributor is the acquisition of Warner Marketplace, as we said, at about a 5.92% yield. So we've got a 6.5-month contribution from that acquisition, which is the most significant number within our growth initiatives. The other positive contributors there are that we are -- we have made a decision to retain our remaining CQR stake for another 6 months. The original guidance in August assumed that we would sell that CQR stake during the current half year. We're now saying we'll retain the remaining CQR stake for the half year, and therefore, we get the full year distribution from CQR.

Thirdly, we have built into our forecast a performance fee for SURF 1. At the moment, that's just an estimate, and our estimate is around $300,000. But in the full year, we will have a much better view as to what that performance fee is, and we'll update that accordingly.

In terms of negatives, well the major negative is the disposal of Cowes that we spoke about, $21.5 million sale value. So those components make up that growth initiatives number, which is the biggest number on that page.

In terms of corporate costs, the major negative area is the D&O insurance that I spoke about before. We've had a very significant increase in that -- those insurance premiums, which is a market-wide issue, not an SCA issue. But given we've only got corporate costs of $13 million, it does show up for us as a significant item. Slight savings in interest expense -- sorry, a slight increase in interest expense due to the increased weighted average debt outstanding, particularly due to the Warner acquisition. And slightly more units on issue because we underwrite our January DRP. The August guidance didn't have an underwrite of that DRP built into it. So those are the components in a bit more detail. Does that answer the question, Andrew?

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Andrew Dodds, Jefferies LLC, Research Division - Equity Analyst [4]

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Yes, no, definitely. And I guess a bit of a follow-on for that is just the, I guess, strategy behind holding onto the CQR remaining units. I mean as you said, we kind of -- we were assuming, I guess, a December 2019 exit for you guys maybe at the back of the August results. So I guess, maybe just some color around that.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [5]

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Yes. Look, our gearing, as we said, when adjusted for the -- those January transactions, the pro forma gearing is down at 32.8%. We're comfortable with gearing at that level. So for that reason, we're happy to hold CQR for a bit longer. Obviously, as we've said previously, it's not a long-term hold for CQR stake. And if there was to be another acquisition in this half, then we'd look again selling the CQR units to partially fund any such acquisition.

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Andrew Dodds, Jefferies LLC, Research Division - Equity Analyst [6]

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Yes, perfect. And then just one final one for me. Just on the rental or the income guarantee provided from Vicinity. I mean are you guys able to give an update on how much of that you've used up so far?

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [7]

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Yes. Look, we -- I'll talk about the full year. So last year, full year, we used a little bit more than $3 million. This year, full year, we're expecting a similar number, so a bit over $3 million. The remainder of the 8, we would be taking into FY '20. That was -- sorry, FY '21. That was a 2-year guarantee, which ends in, therefore, October 2020. So there'll be a little bit less or less for next year, and then that will be the end of it.

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Operator [8]

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Your next question comes from the line of Edward Day from Moelis Australia.

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Edward Day, Moelis Australia Securities Pty Ltd, Research Division - Research Analyst [9]

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Anthony and Mark, just on that rental guarantee, does that cover any reduction in NOI that you're expecting?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [10]

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Yes.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [11]

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Well, yes. I mean what we've said is that in FY '21, we expect the NOI from the Vicinity assets to be the same as when we acquired them. So we are expecting that we'll be back at the beginning earnings, if you like, by the end of the 2-year period, with the trough covered by the rental guarantee. Yes.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [12]

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So there's no shortfall expected or anything like that.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [13]

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Look, again, it's pretty early as yet. We haven't done our budgets for next year. There -- I'm not going to say there won't be any shortfall. The reason for this is that the rental guarantee is based on the let income. And our commitment is in relation to passing income. So there is a small gap between fully let and passing. But until we get through the budget process, which we'll be going into now, well, I'll be able to give you firm numbers on that. But certainly, in August, we'll update you on any potential shortfall.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [14]

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Factor there is, as I said, there is some rental guarantee left for FY '21. So we need to take that into account as well. So a few moving parts in that asset. So let's update you in August on that.

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Edward Day, Moelis Australia Securities Pty Ltd, Research Division - Research Analyst [15]

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Yes, okay. Just on your specialty tenants, your sales metrics look stronger. Clearly, things like there's a little bit of a softening in the leasing environment. Just, I guess, a couple of questions. Can you talk to the 20 long-term vacancies that you leased? Are they a particular type of tenant or a size of space? Sort of back of the implied incentive is -- looks like it's close to 40-odd percent.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [16]

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Yes. Look, those 20-odd longer term, and we call them difficult vacancies are exactly that, they are difficult vacancies. They haven't gone to a particular usage. They're generally some core spaces that are back around the back corner of the shopping center. They have irregular shapes. They're just generally more difficult. We made the decision last year when we did our budgets that we were going to focus on those. That's why when we came out in August with our net operating income -- comp NOI growth of 1.6%, that took into account that. We are still hitting that 1.6%.

But there's no particular specialty tenant type. But we are, again, trying to focus on the tenancies of being nondiscretionary categories that go into those spaces. But -- so it's, again, the food, the medical and pharmacy and those retail services are our preference because they are sustainable, generally more sustainable tenants on those sustainable rents.

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Edward Day, Moelis Australia Securities Pty Ltd, Research Division - Research Analyst [17]

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Right. And the majority of the incentives still appear to be fitout, particularly in those tenants, if there are. Are you there? Sorry.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [18]

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Yes, I said yes, the majority of those fees are for fitout.

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Edward Day, Moelis Australia Securities Pty Ltd, Research Division - Research Analyst [19]

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Yes. Okay. And then just finally from me. Just wondering if we can get your thoughts quickly on the exit of Kaufland from the market space and whether you think that's a positive or a negative overall.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [20]

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Yes. Look, overall, look, it's probably 2 parts to the answer. In the short to medium term, I think it's a positive to us because there was probably -- of the 20 to 30 Kaufland sites, there was probably 8 that would have affected us, being that they were opening in catchments that affected our portfolio. So that's certainly a positive because we have Woolies and Coles in those catchments, and we're not going to go back into those [Cowe] plan developments or it's highly, highly unlikely. So therefore, it's a positive for us in that respect. I think longer term, it's a slight negative for us because having an extra player -- supermarket player in the market isn't necessarily a bad thing as a landlord. So yes, it's short to medium term, there's a slight positive. Longer term, there's a slight negative. So it probably balances out in all respects.

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Operator [21]

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Your next question comes from the line of Adrian Dark from Citi.

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Adrian Dark, Citigroup Inc, Research Division - Director and Analyst [22]

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Anthony and team, you've touched on the -- I suppose, the approach that you're using in leasing up space in the portfolio and perhaps how that might have tilted a little bit. I'm looking at the growth trends slide from 6 months ago. There's a comment in there about positive specialty rent reversion is expected on expiry due to relatively low rent per square meter at present. I think you mentioned today that your rent is still the lowest in the market.

What I'm trying to understand is, is there a shift in, I suppose, your perceptional expectation of market rents? Or is what we're seeing in terms of some negative leasing spreads even in your portfolio at the moment more a function of changing approach on how you're leasing space?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [23]

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I think it's probably a bit of both, to be perfectly honest. We have taken a view that it's more important to keep tenants on and keep the cash coming in the door on our renewals. And so we're probably not chasing as aggressively as we were on the renewal spreads. So we prefer to keep good, sustainable tenants in on those sustainable rents because they will be there for a longer term. So that is the first thing.

And the second thing is, has the market moved at all? I think it has. It is getting tougher. That's why we made that decision to keep our renewal -- increase our retention rates on renewals and lease up those vacancies, particularly to those nondiscretionary categories that we focus on. But yes, we are being affected by, I think, the overall market, that's some of the market is writing lower rents and are writing higher incentives. We are focused on that cash and keeping the cash coming through the door. We focus on our distributions to our unitholders. We're not focused on trying to maintain a high rent and thus, a potential higher value that may not necessarily be there. We focus on getting the cash in the door. I think we're being realistic about that.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [24]

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Adrian, Mark here, I might just add one other thing, which I know you guys know, but just to remind you. Within our specialty leases, they're generally 5-year terms, and we're still getting 3% to 4% annual uplifts. So all we're talking about with this renewal or new lease spread is -- particularly in the renewal spread, is the fifth year. So if we go up by 3.5% per year for 4 years, we might be sort of 15% increase versus where we started and then we go down by 1.7%. So rather than a 15% increase over the 5 years, there might be a 13% increase over the 5 years, and then we start increasing again. So just because we have some negative renewals or new lease spreads doesn't mean that, overall, the rental is decreasing.

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Adrian Dark, Citigroup Inc, Research Division - Director and Analyst [25]

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Understand. I think it's probably a reasonable argument that the negative leasing spreads are driven by the prior increase in passing rents. It does sound like market rent might be softening a little bit at the margin. Are you able to give any sense of quantum on that?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [26]

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Not really, Adrian. I mean it's different -- different categories are being affected to a greater degree. So I think we're seeing some of the discretionary categories are certainly being affected to a greater extent than those nondiscretionary categories.

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Adrian Dark, Citigroup Inc, Research Division - Director and Analyst [27]

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Okay. And just finally from me, could you talk about how you're thinking about transactions at this point? You've been active on both sides of the market this period. How should we be thinking about that going forward for SCA?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [28]

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Yes. Look, we're very keen to continue to grow the portfolio, but we're going to be doing it in a measured way, remain disciplined. Cap rates or yields for good-quality neighborhood centers are still firm around sub-6. They're really good quality stuff. There is still, and there always has been, and I believe there always will be, a fair bit of product that is going to be on the market in that sector. There is always buyers. There's good demand from buyers and, there's always sellers, and I think that will continue, and we will be part of that. There is -- however, it gets different as you get into larger centers. As you get into larger centers, there's the higher number of institutional owners. They're just larger dollar values. And institutions aren't as focused on retail as they have been in the past. And so there's -- you're seeing there's more sellers than there are buyers in that market. And I think the prices there are slightly different to our sector being that convenience sector around $30 million for good-quality neighborhood center that's anchored by Woolworths and Coles, has 10 to 15 shops, they're highly sought after and will continue to be sought after because they're very defensive and they're resilient, and they're not as affected by all of the issues surrounding retail that we read about in the papers every day.

If we -- just like with Cowes, if we get approached and get offered a good price for an asset, we will sell it. And basically, we view it, would we buy that asset for that price? And that's how we determine whether we sell an asset, and that was exactly the case with Cowes.

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Operator [29]

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Your next question comes from the line of Simon Chan from Morgan Stanley.

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Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [30]

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Two questions. The first one, Anthony, you've mentioned several times of that sustainable tenant, sustainable rent. Just wondering, how far are you through your journey to this sustainable tenant, sustainable rent? I mean you've mentioned remixing difficult long-term vacancies you're dealing with. Just is there another 12 months to go, 6 months? Like I'm just trying to figure out how to think about incentive levels.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [31]

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It's ongoing. It's -- retail changes all the time. As we've always said, our focus is on those core categories of food, pharmacy and medical and retail services within those, they change. You used to have doctors that used to work out of their houses. You're now seeing the advent of medical centers, which are in shopping centers a lot more. So things change all the time. We used to have a video store, was very prevalent in every single neighborhood shopping centers.

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Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [32]

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Yes, Netflix now, basically.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [33]

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We have stores now. I think our last one closed last year. So retail changes, we will always change and adapt with it. And so it never ends. The market does change, we will change with it. And what we've really seen over the past 5 years is -- a change from the discretionary sectors are under a lot more pressure. The nondiscretionary have remained very resilient. The terms aren't changing dramatically. They change on the edge. So our -- I mean, what we look at is around 12 months' incentives, and I think that it's still around the case, and we will continue to monitor it. But if we have to move to go to slightly higher because the market is moving that way, we will. If it goes lower, we'll go lower with it. But it will -- for everybody there, it will forever change and we have to adapt and change with it.

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Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [34]

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I guess does this mean we should expect leasing costs and fitout incentives to remain at $6 million per half rather than the traditional $3 million there?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [35]

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Yes. Well, I mean, we're slightly larger than when it was $3 million for the half as well. So we've got a lot more tenants, we're doing a lot more deals. So that's a part of it, but yes, around that level. Mark, do you want to comment on that?

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [36]

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Yes, I think so. But the other thing is we have reduced specialty vacancy from 5.3 to 4.8 this period. We're obviously aiming to continue to reduce that number, and that means doing a higher number of new deals than maybe we've done in the past, and that will also keep that number a little bit elevated. So certainly, for the next 6 months, I'd expect we'll continue to see these sort of numbers. And as I said, in relation to next year, we'll update you in August.

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Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [37]

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Cool. My second question, I've just gone through the full year results in August. I think the expectations you guys had back then for leasing spreads were for it to come down to about 2% to 3% from the traditional 5% or so to give you a comp NOI growth target of about 1.6%. Today, you've reiterated the comp NOI growth target of 1.6%, but it looks like re-leasing spreads are negative. I'm just wondering, like, what is the offset for you to maintain that 1.6%? Were you being ultra-conservative back in August? Or is there a positive somewhere in the constituents of comp NOI?

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [38]

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Yes. If I look at the components of comp NOI, as I said before, in answer to Adrian's question, you've still got most of our specialty leases growing at 3% to 4%. So sort of 80% of the leases are still growing at 3% to 4% in terms of the specialty tenants. So that's a significant positive and probably the biggest single contributor. We've also got the majors rentals increasing because we've got turnover rent increasing, and that will become more and more important if the Woolworths and Coles sales growth continues the way it is. And there are other contributors as well. So as I said, the reduction in vacancy is a positive contributor. Some additional other revenue is a positive contributor.

So the actual impact of negative renewal or negative leasing spreads on a particular financial year is not that large compared to those other items.

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Operator [39]

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Your next question comes from the line of Stuart McLean from Macquarie.

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Stuart McLean, Macquarie Research - Research Analyst [40]

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Just a couple of questions on leasing spreads and tenant incentives. So FFO was up 19% during the year, AFFO up 16%. I was just wondering how you think about that delta and what it means for your distribution. So if leasing conditions remain tough, you pay out 100% of AFFO? So if AFFO is more suppressed versus FFO, your distribution is, therefore, a bit more suppressed? Or should we expect those leasing incentives to maybe improve a little bit into FY '21?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [41]

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Yes.

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [42]

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Look, I don't want to talk too much about FY '21 because, as I've said a couple of times, we're just about to go into the budget process. But this year, our updated guidance is for earnings per unit, or FFO per unit to grow at 3.5%, but the dividend per unit -- distributions per unit only growing at 2.7%. So -- and we've upgraded our EPU, but we haven't upgraded our DPU. So the reason for that is because we are taking into account this high level of leasing and fitout costs in this year.

So your question or comment is true in relation to FY '20, we will see greater growth in FFO than we will in AFFO, if you like. Where we end up in FY '21 will depend on really the market conditions, does it remain soft the way it is at the moment, do market rents and incentives remain sort of a bit under pressure as they are at the moment? That's hard for us to crystal ball at this stage.

It also depends on how far we get in terms of reducing our vacancy. Is there more potential to reduce vacancy in FY '21? That will depend on where we end up in FY '20. So there's a lot of moving pieces there. Certainly, in FY '20, correct, distributions will grow by less than earnings. FY '21, I prefer to wait until August and update you then.

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Stuart McLean, Macquarie Research - Research Analyst [43]

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And just on that, so one of the things that is in your control is the vacancy rate specialty, which is 4.8% at the moment, it's almost at the upper end of your target of 5%. Where ideally would you like that to sit? Would you like that to be closer to 4%? Are you happy with where it is because that could be a [an increase]?

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [44]

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Ultimately, we always like to be right in the middle of all of the ranges, that's why we give ranges. So 3% to 5%, we'd ultimately like to get to 4%. We've said that before. And we will continue to focus on getting it down to around that 4%. When we generally buy acquisition centers, they often have a slightly higher vacancy than our core. That puts us back a little bit. So it's an ongoing focus. But ultimately, otherwise love to be around 4%.

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Stuart McLean, Macquarie Research - Research Analyst [45]

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Okay. And maybe just on acquisition. Warner Marketplace was quite on a cap rate of 5.75%. Just looking at some of the other acquisitions that you've made over the past 12, 24 months, whether it be the VCX portfolio, Sturt Mall, Sugarworld. They're all well and truly in the 6s, if not the 7s in terms of yields. Has there been a bit of a step change in your return hurdles in order to acquire something on a 5.75%?

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [46]

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Well, firstly, different assets have different yields and different growth profiles. Warner Marketplace is in Brisbane. It's in a growth area of Brisbane, has a really strong performing -- Woolworths, a really strong performing, ALDI, development potential. So that's the reason that it's a tighter yield than some of those other ones. But it also conversely has greater growth potential.

In terms of return hurdles, we are still looking for around that sort of 7% to 8% IRR. We -- a couple of years ago, were at 8%. We're probably allowing ourselves now for the right asset to go down to 7%, and that just takes into account the lower cost of capital, both debt and equity, in our assumptions. So ideally, we get 8% IRR, but we will for a quality asset go down to 7% IRR.

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Stuart McLean, Macquarie Research - Research Analyst [47]

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Okay. And maybe one last one for me. Just on Slide 33, just that hedge profile. And I think, Mark, you might have mentioned in your remarks that you'll look to update the market in August about what you do with the $225 million facility that's rolling off. But should we expect your hedge rate to be back around to that sort of 65%, 70% mark? Or should the market be thinking that there's been a change there and you are happy to run with lower hedging?

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Mark James Fleming, Shopping Centres Australasia Property Group - CFO, Head of IR & Director of Shopping Centres Australasia Property Group RE Limited [48]

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No. We've always been around that sort of 60% to 80% is where we like to sit. That's not a hard and fast rule. That's kind of where we feel comfortable. We're probably towards the lower end of that at the moment at 65%. The drop-off that you see on 33 is because of the expiry of the April '21 medium term note, which is obviously a fixed rate note. As I said, in August, we'll update you on a strategy for that, but whatever the strategy is, it will involve increasing our fixed rate or hedge percentage to -- or sorry, to take into account the fact that we've lost that fixed rate, and we'll be doing either more hedging or we'll be doing another fixed rate [note]. So we won't let it drop below 50%, for example.

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Operator [49]

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There are no further questions at this time. I'd like to hand the conference back to today's presenters. Please continue.

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Anthony Michael Grainger Mellowes, Shopping Centres Australasia Property Group - CEO & Executive Director of Shopping Centres Australasia Property Group RE Limited [50]

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Well, thank you all, and I hope the whole reporting season got off to a good start. And we look forward to seeing you all over the next couple of weeks as we start our one-on-ones. But thank you very much for your time this morning, and we will see you over the next couple of weeks. Thanks very much. Bye.