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Edited Transcript of VCX.AX earnings conference call or presentation 14-Aug-19 12:30am GMT

Full Year 2019 Vicinity Centres Earnings Call

Aug 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Vicinity Centres earnings conference call or presentation Wednesday, August 14, 2019 at 12:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Carolyn Viney

Vicinity Centres - Chief Development Officer

* Grant Lewis Kelley

Vicinity Centres - CEO, MD & Director

* Justin Mills

Vicinity Centres - Chief Strategy Officer

* Kah Wong

Vicinity Centres - Acting CFO

* Peter Huddle

Vicinity Centres - COO

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Conference Call Participants

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* Adrian Dark

Citigroup Inc, Research Division - Director and Analyst

* David Lloyd

Citigroup Inc, Research Division - Director & Analyst

* Grant McCasker

UBS Investment Bank, Research Division - Head of Australian Real Estate Research Team, Executive Director & Equities Analyst of Real Estate

* Pete Davidson

Pendal Group Limited - Head of Listed Property

* Richard Barry Jones

JP Morgan Chase & Co, Research Division - VP

* Rob Freeman

Macquarie Research - Analyst

* Simon Chan

BofA Merrill Lynch, Research Division - Former VP

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Vicinity Centres FY '19 Annual Results Briefing. (Operator Instructions) I would now like to hand over to Mr. Grant Kelley. CEO and Managing Director. Please go ahead.

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [2]

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Good morning, everyone, and thank you for joining us today for Vicinity's FY '19 Annual Results Briefing. I'm Grant Kelley, CEO and Managing Director of Vicinity.

Joining me today, in order of presentation, are Kah Wong, our acting Chief Financial Officer; Peter Huddle, our Chief Operating Officer; Justin Mills, our Chief Strategy Officer; Carolyn Viney, our Chief Development Officer; and Penny Berger, Head of Investor Relations.

I'll start by giving a brief summary of our FY '19 highlights, which will then be followed by an overview of our financials from Kah. Following a strategy update, the team will then take you through their respective areas of focus. We'll then close out with guidance for FY '20, and open up the lines for any questions.

Turning to Page 4, Vicinity delivered strong financial and operating results despite a challenging retail environment. FFO was $689.3 million or $0.18 on a per security basis, reflecting 2% comparable growth versus last year. Statutory net profit for the year was $346.1 million, which reflects capital value decline of 1.4%, mainly driven by Western Australia, but elsewhere, the business performed well. And importantly, our strategy of creating market-leading destinations began to take hold.

At the asset level, specialty store productivity at over $11,000 per meter was up by 9.4%. Additionally, our efforts to remix the portfolio to suit contemporary taste delivered tangible results in our specialty and mini major sales or MAT growth doubled to 3.1%. We expanded the luxury precinct at Chadstone with first-to-market brands and flagships, a new visitor's lounge, valet parking and new destination and casual dining offers. Additionally, earlier this month, we opened the final stage of The Glen's $430 million redevelopment. The first 4 days of trading, including the opening weekend, attracted more than 0.25 million visitors. The center now has more than 250 retailers, a new format David Jones and a new indoor/outdoor dining precinct.

We also commenced construction on more than 500 apartments above The Glen in the largest air-rights steel in Australia, which is a great example of proof of concept. Additionally, in the past 12 months, we sold 12 assets for $670 million, including 10 in October 2018 at a 3.9% total discount to June '18 book value, but well ahead of today's downward cycle. Cumulatively, over the past 4 years, we've covered direct portfolio from 88 assets valued at $14.3 billion as at June 2015 to 62 assets today valued at $15.8 billion.

In this time, specialty store MAT per meter has increased by 32%, average asset values have increased 1.7x, and we decreased gearing by 90 basis points while enhancing our investment-grade credit ratings. But given the challenging retail environment, we have decided not to proceed with the proposed VKF wholesale fund and will keep the 7 assets proposed for that fund, together with 5 additional centers previously tagged for outright sale on balance sheet. These combined 12 assets represent about 7% of our portfolio value. The key reason behind our decision is that there is more value for our security holders in keeping these assets and improving them rather than divesting them at a discount.

Elsewhere in the business, we continued our buyback, acquiring 100 million securities at a 12.3% discount to NTA. And finally, as one of the largest retail landlords in Australia and recognizing the integral role we play in creating sustainable destinations for the future, I'm pleased to say that we recently committed to targeting Net Zero carbon emissions for our wholly-owned centers by 2030.

I'll now hand you over to Kah, who will take you through the financials in detail.

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Kah Wong, Vicinity Centres - Acting CFO [3]

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Well, thank you, Grant, and a very good morning everyone. I will start on Slide 6. Our statutory net profit for the year was $346.1 million. This result included FFO of $0.18 per security, partly offset by noncash property evaluation and foreign exchange adjustments. After adjusting for the noncore asset divestments and one-off items, this reflects comparable FFO growth of 2%. This was a solid outcome considering the challenging retail environment, particularly within our WA portfolio, which has impacted property performance and anticipated performance fees from our wholesale platform.

Growth was delivered by: One, development completions at DFO Perth, The Glen and 5 small projects at Chadstone; two, the securities buyback; and three, comparable NPI growth of 1.5%. These were partly offset by an increase in net interest expense from a temporarily elevated weighted average cost of debt following asset divestments. Additionally, there was a small one-off benefit from short- and long-term incentives forfeited upon management changes. This has been excluded from the 2% comparable FFO growth. The AFFO payout ratio of 99.8% remain at the high end of our target range with maintenance and leasing CapEx increasing slightly as active remixing and investment into consumer and beyond continues.

Turning now to Slide 7 and valuations. Over the period, valuations continue to demonstrate the quality of our flagship portfolio, including Chadstone, the Premium CBD assets and the DFOs, with net valuation growth of 3.7% or $264 million over the year, driven by continued income growth. The gains on the flagship portfolio were offset mainly by declines in WA, where the leasing environment remains challenging and assets are being prepared for development. WA assets recorded a loss of 11.6% or $224 million. The portfolio capitalization rate tightened 6 basis points to 5.3%, reflecting a high-quality portfolio.

Moving to Slide 8, and the balance sheet is strong. Gearing of 27.1% remains within our target range of 25% to 35%. A strong A stable rating from Standard & Poor's and A2 stable rating from Moody's have also been maintained. As shown in the bar chart, the reduction in gearing from asset divestments has been offset by reinvesting into developments, the security buyback and movements in asset valuations. Our conservative gearing position provides significant capacity for value-accretive reinvestment into compelling developments at assets such as Chadstone, Chatswood Chase and Emporium.

Moving on to Slide 9, and it has been an active year in capital management. We continue to proactively manage our debt expiry profile and maturities during the year through renegotiating or issuing approximately $2 billion worth of debt facilities. Most recently, in June '19, we issued $400 million of new 6-year MTNs priced at a coupon of 2.6%, which was the lowest coupon achieved by an Australian corporate at the time. These MTNs will replace those expiring in December '19, which have an average coupon of 5.38%.

Our weighted average cost of debt temporarily increased to 4.5% following repayment of cheaper bank debt with divestment proceeds. This is expected to reduce post maturity of the December '19 bonds. We'll also be looking to take advantage of the lower interest rate environment and extend our weighted average maturity over the coming year.

I will now hand you back to Grant, who will update you on our strategy.

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [4]

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Thank you, Kah. Turning now to Slide 11 and to recap. This time last year, we announced our new strategy, namely creating market-leading destinations, realizing mixed-use opportunities and expanding our funds management business. Progress has been steady as we will discuss further in the presentation.

But turning firstly to portfolio repositioning. And as you can see on Slide 12, since facilities formation in 2015, we have made significant progress repositioning and improving the quality of our portfolio. The repositioning program, which is now largely complete, has led to the divestment of some 33 noncore assets at a 0.8% premium-to-book value with reinvestment of proceeds into acquiring 7 new assets for $1.1 billion, which have increased in value by 12.5% since acquisition, buying back approximately $500 million worth of our securities at a 10.9% discount to NTA and investing $1 billion in developments, which have delivered a profit of 12.5%. These initiatives have resulted in significant improvements in the portfolio's key metrics, specialty MAT per square meter increased by more than 30%, while our average asset value has increased by 1.7x.

Turning now to Slide 13. And the decision not to proceed with the proposed VKF wholesale property fund, nor with further outright asset sales is, as previously mentioned, due to subdued investor sentiment towards retail funds globally, compounded by a sales class in Australia with more than $10 billion retail assets currently in the market.

The center's tag for the VKF fund, nevertheless, are high-yielding, with many dominating their respective trade areas. As such, Vicinity had always intended to keep it up to 20% equity stake in these 7 assets. With the combined 12 assets now remaining on balance sheet, we will focus on continuing to enhance the retail mix, leveraging ancillary income, identifying operational efficiencies and making targeted investments as appropriate.

Finally, I would note that halting VKF does not mean we are deviating from our funds management strategy. We intend to explore opportunities, particularly around mixed-use and development funds when market conditions have improved.

Moving now to Slide 14 and external market dynamics. As shown by the chart on the left-hand side, Australian REITs have historically traded in a negative correlation to 10-year government bond yields. That being said, recent low bond yields have not, as yet, materially driven retail equities higher. Partially this is because, over the past 12 months, increased cost of living and declining wages and housing prices have reduced gross disposable income, as shown by the brown line in the chart on the right.

While we see potential tailwinds for income growth in the coming financial year, including income tax and interest rate cuts and lower cost of living which Citigroup expects could inject up to $20 billion into the Australian economy, we nevertheless do expect retail conditions to remain challenging in the near term.

I will now hand over to our Chief Operating Officer, Peter Huddle, who will walk through the portfolio metrics on Slide 16.

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Peter Huddle, Vicinity Centres - COO [5]

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Thanks, Grant, and good morning, everyone. I will start on Slide 16 with a review of some key portfolio statistics. Pleasingly, each of these metrics have remained robust or improved over the past 12 months due to the significant work undertaken over the past few years on portfolio repositioning, which Grant just spoke of, elevated levels of tenant remixing and our focus on driving efficiencies and additional income streams.

Our flagship assets, Chadstone, the Premium CBDs and DFO outlet centers, which are collectively unrivaled in the Australian market, continue to report strong results. As for the remainder of our portfolio, our core performance continues to vary geographically and asset by asset, however, some of Vicinity's strongest enhancement opportunities lie in this segment of the portfolio.

Turning first to geographical performance on Slide 17. The majority of our asset value and the strategic direction of the company is aligned with growth on the Eastern Seaboard, and in particular, Sydney and Melbourne. These regions continue to perform solidly with growth across all key property performance metrics. Overall, the result has been impacted by the prolonged economic downturn in WA. Referencing the bar chart, total leasing spreads for the year were negative 2%. However, the average of the portfolio, excluding WA, is positive 0.5%. Consequently, the portfolio NPI growth of 1.5% was dragged down by performance in WA.

It should be remembered that WA assets represent only 12% of total portfolio value, where we continue to believe in the long-term fundamentals of WA, a prolonged softening in the economy, combined with a mini retail supply burn has weakened market fundamentals there. We have seen signs of recovery, with WA sales in the June 2019 quarter increasing 4.7% to the total portfolio of 2.6%. Furthermore, DFO Perth, which opened during the period, is performing strongly and will soon be supported by the opening of the adjacent first-to-market Costco, where we expect substantial cross-shopping to occur.

Turning now to Slide 18. Vicinity has purposely implemented a remixing strategy of the portfolio in the past few years to focus on growing categories and retailers that are on trend. We continue to write-down areas dedicated to department store, stores and commoditized mid-market apparel and are transferring area to activities and services that are consumed on site, including categories such as food and beverage, health and beauty services and leisure. This impact contributes to creating market-leading destinations.

Remixing efforts have improved sales performance. Mini majors and specialty MAT growth almost doubling, 3.1% -- to 3.1% from 1.6% over the period. Specialty productivity across the portfolio has improved 9.4% over the year to almost $11,100 per square meter. Over the last year, we have improved total leasing spreads, while simultaneously reducing the quantum of short-term deals by 40%. Total leasing spreads, including short-term deals, improved from a negative 4.7% to a negative 2% over the year and excluding short-term deals, improved from 0.7% growth to 2.5% growth over the same period.

Turning now to Slide 19. Further emphasizing our remixing efforts, we see strong growth in jewelry, which is up 9% for the year, driven by Chadstone and our DFO outlets. Leisure continues to perform well, up 6.3% for the year, highlighted by strong performance from sporting goods retailers. Apparel also reported an increase in sales for the 12 months. This is not evidence of an increase overall in apparel trade, but remixing efforts focused on targeting apparel retailers that are relevant to their marketplace and reducing reliance on those retailers that are under pressure.

The present challenges of department stores are well-known in the market. Our exposure to this category is small at only 4% of rent. Many of the top-performing stores are located in our flagship centers, where they continue to invest in their offer so that their performance remains at their strongest levels. Luxury has and will continue to be, a significant strategic focus for Vicinity. An initial look at luxury retailers across the portfolio shows a 40% increase in sales for the year with same-store sales for the luxury segment growing by 5.1%. This category continues to grow and defy economic cycles.

Turning now to Page 20. Further to the prior page, Vicinity is the leader in the luxury retail shopping center segment. Chadstone is Australia's leading luxury shopping center destination. The repositioning commenced in October 2009, with the opening of leading global luxury brands, including Louis Vuitton, Gucci, CHANEL, Tiffany and Burberry. Over the last year, Hermès opened their first location outside of a CBD retail center on Chadstone. And existing brands such as Louis Vuitton and Gucci expanded their presence to ensure that their global flagship format could be presented at the center.

Extending Vicinity's reach further in luxury, this year's Saint Laurent, Fendi and Dior opened at QueensPlaza, which, in addition to Louis Vuitton and Tiffany, further cements QueensPlaza as Brisbane's luxury retail destination. We now have 6 centers offering luxury brands across Chadstone, our CBD centers and the DFO portfolio. Furthermore, we expect Chatswood Chase in Sydney to transform over the next few years to become Sydney's northern home of shopping center luxury for that market.

Looking at the consumers of the luxury segment. Research suggests that 50% of purchases are made by Australian-based Chinese shoppers and 30% from Chinese tourists, who, on average, spend more than double that of other tourists. With significant forecast growth in Chinese tourism to Australia, our premium retail centers are well-placed to support further expansion and productivity within this category moving forward.

Turning now to Slide 21. Based on my experience, I believe Vicinity is at the forefront of using technology to drive efficiencies across the portfolio. Real-time data initiatives are helping to reduce costs and create more efficient buildings and operation. Data has been integrated in the development process, where technology is improving building methodology to make buildings smarter, more efficient and safer. Centralizing processes across the centers create procurement efficiencies with both tendering, economies of scale and clustering has and will continue to reduce our costs.

Increased automation means that centers are no longer reliant on manual labor to complete repetitive standard tasks. We have in operation, 35 robotic cleaners across 31 centers doing labor to complete tasks with greater complexity. This will be extended into scale across our portfolio and is embedded into our key future maintenance agreements.

Our integrated network allows center access and functionality to be controlled from offsite locations, again, reducing labor costs and creating data streams for central analysis. We see enhanced technology solutions continue to be deeply embedded into all of our operational practices.

To further discuss Vicinity's data and ancillary income strategy, I would love to hand over to Justin Mills, our Chief Strategy Officer.

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Justin Mills, Vicinity Centres - Chief Strategy Officer [6]

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Thank you, Peter. I'll provide a brief update on the progress of 2 strategic growth initiatives. Firstly, how we're using data to add bottom line value and how ancillary income initiatives are contributing to future growth.

Moving to Slide 23. We've developed a strong in-house data capability. For leasing, we are continually working on detecting changes and new trends in each trade area that are being reflected in steady and development center decision-making, such as car parking demand analysis and the impacts of mixed-use, to name a few.

Looking ahead, we're developing optimal retail category mix function to forecast sales potential for each center. And through proprietary internal and external transaction data, provide the leasing team with specific tenant recommendations and targeted information to attract those retailers into our malls.

For marketing, real-time feedback on campaign performance enables teams to modify activities to achieve sales objectives or adjust mall activations to increase traffic flow to specific parts of the center. This is assisting sales, and as Peter mentioned, specialty and mini major MAT increased to 3.1%. And pleasingly, in the last quarter, center traffic increased to 3.3%.

Finally, for ancillary income, we know we are winning media campaigns by more accurately targeting the type of share advertisers want and the centers where they're located. Our in-house media sales team increased direct sales by 10% this year, which equated to $1.2 million of incremental income. And to complement those efforts, we are integrating customer journey maps and WiFi dwell time data to determine optimal screen locations. Internal screens continued to generate returns of greater than 40% on invested capital.

So as you can see, our in-house capability plays a critical role in improving the business, and the discovery of new insights provides us with a competitive advantage and agility to navigate a changing retail landscape.

I'll now move to Slide 24. Revenue diversification and net income growth is a key strategic focus. Ancillary income generated $107 million for the year and represents approximately 12% of net property income, but we see that growing to around 15% in the next 3 years. Growth in FY '19 was marginally up, materially impacted by higher but largely one-off energy costs with decreased electricity on selling margins. This, combined with an accelerated withdrawal of ATMs by the banks due to increased mobile payments, impacted total income by $5 million. However, more than offsetting that impact, car park income was up 8%, and our retail media business was up more than 9%, led by the installation of 20 new internal digital screens, bringing our national network to 111 across 31 centers.

Last year, we said we would be focused on growing an external media screen network capitalizing on centers in high-traffic locations. I'm pleased to say we've delivered 11 new external screens this year with a further 10 waiting DA approval. And we believe there is an additional 20 to 30 internal and external screens to be implemented over the next 12 to 24 months.

With solar, we're making good progress on our $73 million program with 12 of 20 sites now energized, with forecast investment returns of 13%. Finally, we will continue to trial, roll out -- and roll out new income initiatives and increasingly leverage our growing digital assets, namely: Our customer database with 1.2 million active users; and 14 million unique mobile devices that connect to our WiFi network each year.

I'll now hand across to Carolyn.

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Carolyn Viney, Vicinity Centres - Chief Development Officer [7]

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Thanks, Justin, and good morning, everyone. I'll start on Slide 26. Vicinity has a $3.3 billion development pipeline. And as Grant mentioned, since 2015, we've invested $1 billion into development projects, delivering an average development profit of 12.5%. We're currently forecasting to spend around $300 million on development annually, and these projects will continue to target a stabilized yield of greater than 6% and an IRR greater than 10%.

The current pipeline is focused on our flagship and strategic assets on the East Coast, primarily in Melbourne and Sydney to benefit from population growth and strong local economies. These major investments require significant planning and buying from various stakeholders. While discussions can be lengthy and complex, we are focused on reducing the time taken from initial planning to a project's completion, whilst also ensuring the right focus on derisking projects before committing capital and commencing construction.

We also have the strong advantage of our significant in-house data capabilities, which we are using to better inform decision-making in the development process. We are leveraging data out and, importantly, integrated information, such as traffic flows, dwell times, mapping and building operations for our developments. And as a result, our development projects are planned with greater understanding of how customers use our centers and how they will use our centers into the future, to offer our retail partners an optimal opportunity to success and bring our vision for our centers to life. You can expect to see me working even more closely with Peter and Justin and their teams to further leverage these strengths.

I'll now move to Slide 27, and an overview of the projects progressed in the last 12 months. DFO Perth opened in October 2018 and has been a well-received addition to the DFO footprint. All 113 retailers opened to trade on the first day, including a number of new WA brands. The $140 million project posted a material net valuation gain post completion, a great outcome for the business. We expect DFO Perth to report further productivity improvements with Costco and other retailers opening at the airport precinct next year.

The final major stage of The Glen opened on 1 August, with more than 250,000 customers through the doors on opening weekend. Slide 25 has a photo of the new indoor/outdoor dining precinct that our customers now enjoy. Stage 3 opened in October last year with the international flagships, Uniqlo and H&M. Today, The Glen has more than 250 retailers, including a new format David Jones.

Construction of more than 500 apartments at the top of The Glen commenced earlier this year also, as Australia's largest residential development over a retail center. The Glen has a forecast development yield of greater than 7% and IRR greater than 13%.

We continue to evolve our luxury and customer experience at Chadstone, expanding the luxury precinct with new flagships and first-to-market brands, a new visitors lounge, valet parking, 2 new signature dining destinations and new dining atrium, and we opened Australia's first full line Victoria's Secret.

Turning now to Slide 28. Hotel Chadstone is on track to open in November this year, with advanced bookings of the rooms and functions exceeding our expectations. The hotel is the next chapter in Vicinity's mixed-use story and is expected to attract business travelers to the growing Monash corridor as well as catering to the 24 million people who visit Chadstone every year, including more than 0.5 million visitors from overseas came to experience, shop and dine in Chadstone.

At Ellenbrook in WA, we've commenced a $63 million expansion to introduce Kmart, mini majors and additional specialty retailers, reinforcing this center's dominance in Perth's northeast growth corridor.

Turning now to Slide 29. Planning is well advanced for the major redevelopment at Chatswood Chase with the DA for the project received earlier this year, a major milestone. The DA adds approximately 35,000 square meters of additional GLA and enables us to transform and reposition the center, creating the best mix of retailers for the highly affluent demographic and strong international tourist market which visits Chatswood. With DA in hand, we're currently working through the detail design process, while the leasing team is aiming to reduce the overall project risk by progressing deals with key retailers prior to commencing construction in mid-2020.

Turning now to Slide 30. We continue to progress the prioritized mixed-use development projects. These projects take advantage of the opportunity to densify key assets along the Eastern Seaboard in urban locations experiencing population growth and aided by transport connections. This includes significant work completed with multiple stakeholders at Box Hill. Our proposal thesis consolidate our retail holdings into 1 land parcel, freeing up the other parcel for higher-density mixed-use development of up to 350,000 square meters of developable area.

The next step is lodgement early next year of a DA for the first of those buildings as well as the retail redevelopment. A DA is also expected to be submitted for Bankstown, which, along with an indicative master plan for the whole site, realizes approximately 310,000 square meters of developable area.

We continue to investigate a range of retail and mixed-use development options at Chadstone as well as opportunities at Victoria Gardens, QueensPlaza, Buranda and Emporium Melbourne.

I'll now hand you back to Grant.

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [8]

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Thank you, Carolyn. And turning now to Slide 32 and FY '20 guidance. And consistent with our FY '19 result, we expect retail conditions to remain challenging in the coming financial year. After adjusting for divestments and one-off items realized in FY '19, which were mentioned by Kah previously, comparable FFO growth is expected to be in the range of 1.7% to 2.9%. This equates to FFO per security guidance of $0.178 to $0.18.

Distributions are expected to remain at the upper end of our policy range at 95% to 100% of AFFO, equivalent to 85% to 90% of FFO. And we expect the maintenance and leasing CapEx requirements for the portfolio to remain stable at approximately $80 million to $90 million.

Moving now to Slide 33. And to summarize, Vicinity has delivered solid results in a highly challenging retail environment, demonstrating the resilience of our portfolio and reinforcing our market-leading destination strategy. Vicinity's balance sheet remains strong and positions us well for the future. And we've largely completed our asset divestment program, strategically repositioning the portfolio ahead of the cycle, and as mentioned, we will not be divesting further assets given the current mispriced market.

And finally, in closing, we strongly believe we are well advanced in repositioning Vicinity for the future. We remain confident in our strategy to create long-term value and sustainable growth for our security holders.

I will now open up the lines for any questions. (Operator Instructions) And I'll now hand back to the moderator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Simon Chan with Morgan Stanley.

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Simon Chan, BofA Merrill Lynch, Research Division - Former VP [2]

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My first question. Now that you've made the decision to not go ahead with VKF and I guess some of the other asset sales, can you give us some color around how far you actually got and some of the issues that came up? Because my understanding is you actually got pretty close to getting off the ground once or twice along the way.

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [3]

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Simon, thanks a lot for that question. I think it's fair to say that we commenced the journey on wholesale maybe a little late to the market. And we caught the tail end of what was still quite a positive environment for wholesale funds, generally, which is the market that existed in mid-2018 when we announced the planned fund with Keppel. We did get quite close at different points. But I think really the key point is and why we're actually saying we won't be proceeding is that we have about 3x the average annual sales volume of retail assets currently in the market. And on any measure, that's going to lead to mispricing. So it doesn't really reward our security holders for having financed these assets for many years to continue to seek to market them in what is clearly a very unforgiving sales environment.

The other quick comment I'd make, Simon, is that we felt that this VKF fund was becoming a distraction, quite frankly. We've looked at the assets in the document that we presented today because I want the market to know, actually, these assets are not our premium flagship or DFOs. These are assets which represent, again, 5% of the book in terms of the VKF proposed assets and only 2% of the book for the assets planned for outright sale. And we felt that the market was getting, in some sense, preoccupied with this question of whether VKF would be raised or not. And aiding that, I think, judgment call was the fact the wholesale assets particularly, have performed really well. The sales MAT was 3.5% for the year. The traffic counters are up 3.5% for 6 months, 4.7% for the past 3 months. Our occupancy at 11% is a little low, but these assets are #1 or 2 in their typically regional markets. So we thought about taking these assets back on balance sheet in a market that is favoring yield rather than capital, this was a prudent call for our security holders.

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Simon Chan, BofA Merrill Lynch, Research Division - Former VP [4]

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Yes, fair enough. My second question on developments. Carolyn, you mentioned you're targeting $300 million a year of developments. Just on FY '20, I'm struggling to see how you'd get to that number because you only have Ellenbrook kicking off, right? Is FY '20 a bit of a dip?

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Carolyn Viney, Vicinity Centres - Chief Development Officer [5]

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Look, we provide $300 million annually as the guidance of what we see as the average through a period of time. You've got, as well as the small project that you're talking about there at Ellenbrook. You've got, obviously, our largest project at Chatswood Chase, a large -- this is a very large project kicking off at Chatswood Chase in that time period, and we expect there's some other retail developments that will kick off in the same time frame, subject to [VAs] being granted.

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Operator [6]

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Your next question comes from Adrian Dark with Citi.

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Adrian Dark, Citigroup Inc, Research Division - Director and Analyst [7]

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Apologies if I've missed this, but could you talk about the status of the buyback following the decision not to pursue other asset sales, please?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [8]

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Yes. So Adrian, the buyback is currently what we deployed, $100 million over the past 12 months and $500 million, cumulatively. Excuse me, 100 million securities over the past 12 months at a 12.3% discount to NTA. We have refreshed the buyback mandate with our Board, and we'd seek to acquire securities where we believe they represent good value for acquisitions. So the buyback essentially is going to be switched back on. And we think that looking at having what's occurred in the past 12 to 18 months on the buyback, it's highly accretive for our security holders.

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Adrian Dark, Citigroup Inc, Research Division - Director and Analyst [9]

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And perhaps one for Peter on the operational side. I'm just looking at the performance of the core portfolio, the majority of the portfolio by number of assets. And at the moment, we're looking at comp NPI growth around minus 1.1%. Could you maybe talk about some of the things that you could do to improve the performance of that portfolio and perhaps when you see it reverting to some sort of normalized or positive growth?

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Peter Huddle, Vicinity Centres - COO [10]

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In terms of the -- there is a separation in the portfolio, the premium portfolio is performing well. The core portfolio has been flattish. A part of that, we spoke in here, is related to Western Australia. Another part of it is we have been doing a lot of re-tenanting activities within some of the bigger assets within that core portfolio, that takes time to actually get through that process and has also impacted NPI during that process. We're through a lot of those larger assets now, and we see those assets being able to accelerate growth on NPI moving forward.

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Operator [11]

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Your next question comes from Richard Jones with JPMorgan.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [12]

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Grant, just in terms of the valuation of the 12 assets that you were looking to sell, what happened to those values in the second half?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [13]

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Yes. Rich, I'll just ask Kah to talk about that in the initial phase. Go ahead, Kah.

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Kah Wong, Vicinity Centres - Acting CFO [14]

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Richard, I might break that up into 2. So the 5 assets that we were looking to sell, the movement from the 6 months was down by about $28 million or minus 6.9%. To finish that off, the VKF portfolio, that moved minus $14 million roughly or roughly minus 2.3% in the 6 months.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [15]

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Okay. And Grant, can you discuss kind of where the -- you and the Board kind of considered the in specie distribution of perhaps the dozen assets and maybe a couple more?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [16]

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Yes, thanks, Richard. We actually look at every option for maximizing asset value and, by implication, security holder value. On in specie, in particular, we have considered it in the past. We don't believe it really creates value given that it creates dyssynergies. So it actually leads to operationally challenges.

The other comment I'd make is that in specie typically worked best in rising not declining markets. So it's something that if you see a macro market recovery, I think it becomes something that's worthy of closer scrutiny, I think, in a declining market, and you've -- given your first question was just is on asset valuations, it doesn't really make sense to pursue it versus the other options that we contemplated.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [17]

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Okay. And then one more, if I may. Just any major tenant departures that you've got coming up in the next 12 months that you can call out?

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Justin Mills, Vicinity Centres - Chief Strategy Officer [18]

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We haven't concluded any at this stage. We're in discussions with the major retail partners. It's well-known that certain, such as Big W, are looking to rightsize their portfolio. So they're all subject to long-term leases. They're valuable partners of ours. So we're in negotiations with them at the moment. We do expect to get some space back. And in a lot of cases, we actually think that would be more productive for the asset moving forward.

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Operator [19]

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Your next question comes from Grant McCasker with UBS Investment Bank.

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Grant McCasker, UBS Investment Bank, Research Division - Head of Australian Real Estate Research Team, Executive Director & Equities Analyst of Real Estate [20]

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I just wanted to ask a question on the balance sheet that you're talking about a buyback, $300 million level per annum on development, plus a period of declining asset values. I want to get your views on what you see is the right level of gearing through this -- at this point and also through the cycle.

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [21]

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Yes, thanks, Grant. And just to clarify one earlier point, the FY '20 guidance does not assume any buyback. So those numbers are independent of a potential buyback with stock.

Look, currently, as you would have seen on Slide 8, we're at about 27.1% gearing with very healthy ICR and debt-to-EBITDA ratios. And that 27.1% in the near term, if we need to fund, for example, the development pipeline, given that we're not now selling the 12 assets that were tagged for wholesale and outright sale respectively. So we've given guidance in the 25% to 35% range. I think the market's become conditioned to the lower end of that range for Vicinity, but we're fairly relaxed if we have to go up 2 or 3 percentage points over the next 2 years in order to keep the development pipeline fully funded and accelerated.

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Grant McCasker, UBS Investment Bank, Research Division - Head of Australian Real Estate Research Team, Executive Director & Equities Analyst of Real Estate [22]

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Okay, excellent. And then just moving to the ancillary income. Did I just hear that right, that you expect that to accelerate to roughly 15% of NPI? Can you talk through sort of that's assuming that reflects 10% plus growth relative to the existing NPI? Can you talk through the actual key drivers of that? Is that sort of the CapEx -- or sorry, the return on CapEx from solar or is it media? Can you just...

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Justin Mills, Vicinity Centres - Chief Strategy Officer [23]

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Yes. Thanks, Grant. About 1% is from solar, and the rest is really from the expansion of the media network, both the internal screens and external screens, is that similarly, there's a pipeline for paid car parking and a number of other initiatives that I sort of touched on around that digital space, utilizing our database and the 14 million unique devices that we connect to through the WiFi network.

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Operator [24]

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Your next question comes from Rob Freeman with Macquarie.

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Rob Freeman, Macquarie Research - Analyst [25]

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Just on the dividend and on cash flow. So obviously, you've called out AFFO this year is down 4%. If I have a look at your operating cash flow, that's down about 6%, combined with maintenance CapEx incentives up 10, obviously, sitting in the investing line. Your free cash flow is actually down 8%. So at twice the rate of the AFFO change, which obviously starts with the P&L FFO number. Given gearing might creep up, obviously, a few rates have been getting in trouble globally, just if there are some higher devals, et cetera. When does kind of cash become a more suitable metric for the dividend than AFFO, please?

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Kah Wong, Vicinity Centres - Acting CFO [26]

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Rob, it's Kah. Look, the difference you mentioned there about -- that's actually because we changed the treatment of Chatswood Chase to equity accounting. So literally, we net off CapEx spend at Chatswood Chase with the NPI distribution which goes through operating cash flow.

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Rob Freeman, Macquarie Research - Analyst [27]

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How much of the difference would that explain?

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Kah Wong, Vicinity Centres - Acting CFO [28]

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That would explain about $10 million to $15 million.

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Rob Freeman, Macquarie Research - Analyst [29]

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Okay. I'll go through that. But just to be clear, like when does cash flow become more important for the dividend rather than talking about 100% of AFFO?

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Kah Wong, Vicinity Centres - Acting CFO [30]

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We are cash covered, Rob. It's always.

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Rob Freeman, Macquarie Research - Analyst [31]

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Okay. And then just on these asset sales, Grant, you've called out a declining market in some Q&A. I think you referenced the [SCT] transaction as being a good one given today's downward cycle. When does the decision just get made to kind of take the discounts that obviously are being bid today, given your view that the market will keep declining?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [32]

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Look, it's a great question, Rob. So first and foremost, on the 7%, right, of assets under management are actually in this bucket. And of that 7%, 5% were wholesale, and the intention had always been to keep an equity tranche of that anyway.

So let me focus on the 5 assets which are -- which were tagged rather for outright sale. And we've listed them in the document. From our perspective, we're always evaluating offers, and we're always evaluating acquisitions. And it's the nature of our industry that if you're a good management team, you never are static on your portfolio.

We're just in a market currently where we can't see fits that make any sense whatsoever. And we're also in a market where multiple seems to be much more -- or much less rather important than just, frankly, to your earlier question, cash flow from the dividend.

So we always evaluate. There's no hard and fast rule. It's a fairly complex screening, which involves every member of the Executive Committee in their respective areas.

If you look at (inaudible), Carolyn Viney's team will evaluate heavily with this mixed-use potential given the growth in the Geelong corridor in the next 10 years. If you looked at some of the other assets we have say, for example, Lennox we would question whether we have a need for 2 centers in Western Sydney that both do very well. So that's a strategic call.

In the case of Maddington in WA, we've got enormous acreage around the center positioned, again, right in the growth corridor in Perth. So there's no hard and fast rule. It's not formulaic. It's -- I would say, in large part, strategic. And that very much has driven, frankly, the decision to bring these assets back on balance sheet.

And again, I just want to emphasize. I think we've become distracted by, frankly, 2% of the portfolio. The 5% in wholesale we'd always said we were rolling equity into. So we're actually focused on 2% of our business, and we spend 40% of our airtime discussing it, which is fine, but I don't really think it's going to materially alter value creation for our shareholders to a great extent.

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Rob Freeman, Macquarie Research - Analyst [33]

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And then just one more quick one. Slide 40 has got all the noncomparable centers. It looks like Galleria is still in there at the predevelopment stage. Could we just get an update on Galleria? I couldn't see it in kind of Carolyn's development section.

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Carolyn Viney, Vicinity Centres - Chief Development Officer [34]

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Thanks, Rob. It's Carolyn. Look, we talked last time around about the fact that we had decided at the present time not to pursue a major redevelopment of Galleria, having regard to a range of things, including market conditions in WA principally. We've obviously had that asset development held for a period of time. So the immediate strategy there are a range of initiatives, which include significant remixing. And once we've come through that process, we'll put it back in the comp basket. It needs to be normalized, I think, in order to do that.

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Rob Freeman, Macquarie Research - Analyst [35]

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But just to be clear, it's not really predevelopment because you're not going to develop it?

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Carolyn Viney, Vicinity Centres - Chief Development Officer [36]

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Well, it's not going into a major redevelopment, but it's a large asset that's being held for development for a significant period of time. And in order for it to be truly comparable, it needs to be back into business as usual, leasing and asset management. 5% of GLA of that -- more than 5% of the GLA that's interest development impact it, and that's why it's being taken out of the basket.

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Rob Freeman, Macquarie Research - Analyst [37]

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Right. And just -- I haven't put this slide in a spreadsheet yet. How much of the portfolio is sitting on Slide 40?

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Carolyn Viney, Vicinity Centres - Chief Development Officer [38]

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About 20%.

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Operator [39]

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Your next question comes from David Lloyd with Citi.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [40]

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I just want to follow up on a couple of things that were said today. Just firstly, just with the divestments being held so there are no more asset sales. Are you essentially trying to signal that you think this is the bottom of the asset value cycle?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [41]

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That would be fantastic -- yes. No, sorry, David, go ahead. Sorry. I cut you off.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [42]

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No problem. Are you saying that asset values are now starting to bottom and that they're not going to get any worse?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [43]

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Well, I think what we're saying is that we don't see value where asset prices are being bid, which is probably similar to what you've identified. But from our internal analysis, which is, in some sense is, more important to our security holders, it just doesn't make sense to try to clear a market which is against you.

And on the more macro question, I don't know. I think retail ultimately always gets priced as capitalized income. I think there are income drivers coming through at the macro side. For example, the tax rate cuts, et cetera, which -- and the interest rate cuts, which we talked about. And also, I think our portfolio is really well positioned with offshore buyers, as Peter highlighted in his slide on luxury. So it's more of an internal call that we just will back ourselves, frankly, to capture greater value for our shareholders by holding these. And if that changes, if we get attractive bids, then obviously we'd consider it. But we just really wanted to, in a certain sense, just take this issue off the table. So that for all of you guys when do your modeling, et cetera, you know where we are. And I think, hopefully, we've done that today.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [44]

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Sure. Just a quick follow-up to Grant's question on the balance sheet. I think the ride -- you said, look, you have to ride the gearing up to 300 basis points to push it to complete development. As far as -- does that then assume that there's no further deterioration in asset values?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [45]

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I think what it assumes is, the short answer is that the market is bifurcating in asset values, okay? So it's tough to say our asset value is rising or falling. The truth is they're doing both. As Peter and Kah highlighted, the destination centers have been revalued upwards. That will likely continue, given the MAT numbers we're seeing and the compressing leasing spreads and quarantining Western Australia. But look, we all know, and it's become a truism that subregional centers are challenged if they don't have nondiscretionary food, in particular. So I don't think you can generalize. And I think what you, therefore, need to do is work the asset-by-asset story, which is one of the key reasons we hired Peter Huddle, was to actually understand at the asset level the drivers for micro demand in that trade area and to actually drive that along with mixed-use opportunity as hard as we can.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [46]

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Okay. And just one last question from me. I'm just referencing the slide, I think it's up front of the pack around the growth strategy -- growth strategy, I should say. The third pillar of that is capital partnering and that sort of sends the link into the 2 other bubbles. Given where the capital is essentially sitting on the sideline at the moment, should we be thinking a little bit more of an elongated sort of time frame to complete some of these mixed-use opportunities?

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [47]

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Yes. I think -- I'll let Carolyn answer that at the project level if that's helpful. But one of the things you learn over time is not to fight the tape, as they say, in New York City. We are very confident in the long-term strategy. We -- I think we get paid as a management team to look through the cycle. It's why I've moved the entire method of compensation for the executives around this table to LTI and away from STI. And yes, I mean, you may have some longer time frames. But again, you can't generalize. If you look at a micro project, like say, Box Hill, we're now looking at actually fractionalizing the development approvals because we want to accelerate time to market for both the retail box and potential mixed-use. So by contrast, a really complex mixed-use project, such for example, Bankstown, which is contingent upon a rail link, yes, maybe elongated. So again, it's at the micro level, you have to look. And this is where I rely upon the talent of my executive team to make those calls alongside of myself and the Board.

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Carolyn Viney, Vicinity Centres - Chief Development Officer [48]

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Yes, the thing I would add to that is, there's a range of shorter-term opportunities that we see in that mixed-use space. They include opportunities at Emporium, Queens Plaza, Chadstone, Victoria Gardens, which again is completely aligned with the strategy we have to invest in those CBD flagship and strategic assets. Bankstown and Box Hill, we're still counting that strategic high-performance category, but they have a longer lead time into them, which is completely commensurate with the fact that the level of value we are unlocking in both those cases where there's more than 300,000 square meters that we're looking to achieve, that, that's a longer process to get that outcome effectively out of the government town planning controls. But well worth it, given the size of the prize.

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Operator [49]

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Your next question comes from Peter Davidson with Pendal Group.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [50]

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Look, I'm on Slide 16. I just got a question about the core portfolio. It's got minus 8% leasing spreads. Comping NPI on the right there is minus 1.1%. Can you just walk me through the level of retentions and the level of income growth in the retained portfolio? I've was sort of -- I think about -- assuming it's about 30%, that's about 1.9% NPI growth. So I'll leave it up to you.

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Peter Huddle, Vicinity Centres - COO [51]

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It's Peter Huddle here. Essentially, our overall retention rate in terms of renewals is around 65%. Obviously, there's a correlation between NPI flow on which sales increases. So as you know, we're renewing about 20% of renewals on a yearly basis. These obviously continue to grow sales, and we'll see the leasing spreads improve over that scenario. But it's around 65% retention rate.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [52]

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Okay. So it's sort of growing at about 2.7%. So what's the sort of -- if you compared that with sort of the underlying lease deals, they would be at 3 or 3.5 or 4. So can you just walk me through what that piece -- what's going on there?

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Peter Huddle, Vicinity Centres - COO [53]

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So the majority of our leasing structures are still at a 5% per annum leasing growth on those deals. So hence, the reason when sales are not growing to that level, there is some negative reversions. But we are essentially holding the vast majority of our leasing structures flat at a 5% yearly growth.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [54]

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So if there are 5, is there more downtime or something like that or what's...

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Peter Huddle, Vicinity Centres - COO [55]

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No, so fundamentally, you -- it's blended with negative leasing spreads and it's also blended with a large proportion of our deals -- large proportion of the income coming from major retailers that traditionally don't have the same structures in terms of yearly growth.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [56]

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Okay. All right. Just another one. Just with regard to holdovers, arrears and mix of cost deals. Can you just walk us through that? So sort of indicators you've seen in health.

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Peter Huddle, Vicinity Centres - COO [57]

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Yes. So in terms of holdovers, we've reduced the amount of holdovers in this reporting period from the prior one. So presently, in our portfolio, at the moment, we have around about 6.5% to 7% of our portfolio is on essentially holdover arrangements. So I think it's roughly that 600 out of 7,000 leases. So that's basically where we're at.

A lot of those holdovers are actually associated with impending developments as well where we're looking to obviously recapture that space and develop into more productive uses.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [58]

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And arrears and mix of cost deals?

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Peter Huddle, Vicinity Centres - COO [59]

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Arrears were about -- 1.3% is the current arrears, which is -- some of that is related to some legacy disputes, which we're working through at the moment, which represents about 10% of that 1.3% and associated with major retail.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [60]

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The last one was mix of cost deals?

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Peter Huddle, Vicinity Centres - COO [61]

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In terms of cap deals, cap deals is a small percent in our portfolio. It represents about 100 deals of about 7,000-plus leases. We're typically only doing capped up cost deals where it's specifically targeted at key retailers that we're looking at and primarily to introduce to new developments where they have untested performance areas. Some of those capped up cost deals also crystallized during the period of the lease.

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Operator [62]

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

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Grant Lewis Kelley, Vicinity Centres - CEO, MD & Director [63]

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Thanks, Ashley, and ladies and gentlemen, that concludes our formal presentation for today. Thank you very much for your time this morning, and we look forward to catching up with many of you over the coming weeks. Have a great day. Thank you.