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Edited Transcript of VVR.AX earnings conference call or presentation 22-Aug-19 12:00am GMT

Half Year 2019 Viva Energy Reit Ltd Earnings Call

Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Viva Energy Reit Ltd earnings conference call or presentation Thursday, August 22, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Guy Farrands

Viva Energy REIT - CFO

* Margaret Kennedy

Viva Energy REIT - MD

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Conference Call Participants

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* Krzysztof Kaczmarek

JP Morgan Chase & Co, Research Division - Analyst

* Pete Davidson

Pendal Group Limited - Head of Listed Property

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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 Viva Energy REIT Half Year 2019 Results Conference Call. (Operator Instructions) I would now like to hand the conference over to Ms. Margaret Kennedy, Managing Director, VER Manager. Please go ahead, ma'am.

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Margaret Kennedy, Viva Energy REIT - MD [2]

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I'm the Managing Director of VER Manager, which is the manager of Viva Energy REIT. And on behalf of myself and my colleague, Guy Farrands, the CFO, I'd like to welcome you to the half year results call for Viva Energy REIT, reminding you that Viva Energy REIT is a December balancer, so this is half year. There will of course be an opportunity for questions at the end of the presentation.

So you'll see our long disclaimer, which I trust that everyone's had the opportunity to read and digest.

So if I touch on our half year 2019 performance. During the first half of 2019, Viva Energy REIT has continued to deliver on our strategic objectives. We've returned statutory net profit of $56.9 million. We've announced a distribution of $0.0718 per security, and we remain on track to deliver our 2019 distributable earnings guidance that we've provided you in February at the time of our 2018 results and our capital raising. Our guidance has been provided at a growth rate of 3% to 3.75% over our 2018 results.

Our portfolio continues to provide income growth from an enlarged asset base through 3 key areas. We have the contracted rental growth of 3% annual rental increases in 95% of our portfolio. We continue to deliver upon our acquisition pipeline with approximately $80 million of properties currently under consideration, and we've now commenced asset improvements through site optimization activity and a number of fund-through developments.

To support the ongoing growth, our balance sheet's been refreshed with $115 million of new equity raised in the first half. Our gearing is at the low end of our target gearing range and the hedge book has been partly restructured.

On Slide 6, you'll see our financial performance has a distributable earnings of $0.0718 per security, which is up at 2.7% on the first half of last year. Our NTA is $2.18 per security and our MER, at 23 basis points, remains one of the lowest in the sector. That's reflective of the triple net lease structure in the majority of our leases.

Our portfolio continues to grow and is now at $2.54 billion made up of 464 properties at a weighted average cap rate of 5.8%. Our WALE is 12.1 years with fixed 3% rental escalators. During the first half of 2019, we've acquired properties and funded developments totaling just over $43 million with a commitment for an additional $21 million of additional expenditure to occur on some of these properties.

Our balance sheet has significant room for growth through the injection of approximately $115 million of new equity in the first half. The gearing ratio of 33.4% is at the lower end of our target range, and our weighted average cost of debt was 3.83% as of 30th of June.

I'll now move on to the portfolio and acquisition overview. Viva Energy REIT's portfolio remains geographically diversified in line with the customers with 83% weighted to the most populous Eastern states in Australia. Approximately 3/4 of our properties by value are located in metro areas, reflecting the underlying quality of the portfolio. There are 464 properties valued at $2.54 billion with an average cap rate of 5.8% across the portfolio and a WALE of 12.1 years.

We continue to diversify the portfolio brand mix with approximately 5% of our income from sources now other than Viva Energy. More than 93% of our leases are triple net, and more than 95% of our rental income falls on the fixed 3% rental increases, with the Viva IPO portfolio rental increases happening in August.

If I move on to growth on Slide 9. As outlined in my introductory remarks, there are 3 pillars to the growth in the Viva Energy REIT portfolio. First is the contracted rental growth, which is derived from the long-term leases which, of course, are predominantly the IPO portfolio. Even with no additional acquisitions, the baseline rental grows annually by 3%.

The second is the continued acquisition activity. The team at Viva Energy REIT have demonstrated their capability to continue to deliver against the strong acquisition pipeline. The ownership market for these service station and convenience properties continues to remain fragmented, presenting further opportunities for expansion. The current low interest environment will see demand from private buyers for these types of assets continue to remain strong.

Our business continues to apply a disciplined approach to acquisitions which, to date, have been sourced off-market and with each acquisition evaluated against our investment criteria. Fundamental to each acquisition is the quality of the underlying real estate and assets, the geographic spread and diversity of assets, the lease covenants and quality of the tenants and that those investments have potential for future capital growth.

The third pillar for growth is in the area of asset improvement initiatives. Viva Energy REIT can act as a capital partner to support the growth aspirations of Viva Energy, our majority tenant, Liberty Oil and potentially others. Viva Energy REIT has invested 16 -- approximately $16.5 million in development fund-through projects with a further $21 million committed for the second half of 2019 and a smaller add into 2020 for these projects. These site optimization projects have the potential to unlock additional value for Viva Energy REIT.

The chart on Slide 10 provides a breakdown of the acquisitions made in the first half of this year comprised of 3 components: the acquisition of operational trading sites, the acquisition of development sites and the fund-through of development costs associated with those development sites. That's the 3 bars you see on the left. The total acquisitions, including development costs in the first half, has been $43.7 million. In addition, as I mentioned earlier, there are further commitments of approximately $21 million associated with those development sites which are likely to occur in the second half.

The pipeline of acquisitions continues to remain strong with a further $80 million of acquisitions either in due diligence, at approval stage or under offer. Since the time of the Viva Energy REIT IPO just over 3 years ago and, boy, has time flown, the business has continued to add additional fuel and convenience tenants to the portfolio. The portfolio has grown from the initial 425 properties valued at $2.1 billion to over $2.5 billion of assets from 464 properties.

Diversity of brands reflects the opportunity set that is being pursued and whilst Viva Energy remains the tenant for more than 90% of our income, other major tenants have emerged through acquisition. In addition to these sites, we have one further 7-Eleven site, which completed earlier this month.

Viva Energy REIT invested $17 million in the first half of 2019 on fund-through projects and project development. So these projects are all earning a 7% yield with a further $21 million of funding committed to be delivered on these sites in the second half of this year and first half of next year.

If we move to Slide 13, we've put something together in terms of our strategic relationship with Liberty Oil, and we've worked closely with Liberty Oil through established relationships to develop a significant portfolio of assets, with Viva Energy REIT now holding more than $110 million of properties by value which are leased to Liberty Oil. 68% of that has been spent on site acquisition and 32% of that has been spent on development funding.

We have a long-standing relationship with Liberty, and I personally worked with the principals of Liberty for more than the last 10 years.

You can see on the map in the middle of the page that the Liberty properties and assets acquired by Viva Energy REIT are geographically diversified across Australia. And while somewhat skewed to regional locations, the sites are typically brand-new or redeveloped assets with large format truck stops and a full convenience offer, many with restaurants that include sit-down foodservice.

The Liberty leases are typically triple net with prime terms of 15 years and with fixed annual rental increases of 3%. The average cap rate for our Liberty portfolio of 6.9% reflects the investment in the development funding as well as the regional nature of these sites.

On Slide 14, we've presented a case study on one of the site acquisitions in development that Viva Energy REIT is currently conducting with Liberty. Richmond in Queensland is strategically located between Townsville and Mount Isa, making it an ideal rest location for drivers, especially truck drivers who may be managing their hours. The new site will comprise a large-format fueling facility with separate truck diesel canopy and driver facilities as well as a 500-square-meter integrated convenient store and restaurant. Whilst the site is operated by Liberty, it will be a Shell-branded facility. For information, the land was purchased for $1.6 million and the development funding of $6.3 million is reflective of the size of the development as well as its location. The lease is for 15 years commencing in the second quarter of this year, triple net with fixed 3% rental increases. Whilst each of the Liberty development we've done is different, this example is reflective of the site offer with fuels, convenience store and food all being central to the key customer offer.

I'll now pass across to Guy to take you through the financial results and capital management.

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Guy Farrands, Viva Energy REIT - CFO [3]

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Good morning, everybody. As you could have gathered from what Margaret's just said, it's been a pretty busy month -- a pretty busy 6 months here, and that is reflected in the numbers.

So if we look at the statutory profit on Page 16, I want to call out a couple of things here. Firstly, you'll see rental income is significantly up. So why is that? Firstly, we have 3% rent escalators on 95% of our assets. And of that, 92% is the IPO cohort, which increases by 3% every August.

And the second is acquisitions. Firstly, 8 acquisitions were made in the second half of FY '18, so this is the first full half that they've contributed. And secondly, in the first half of '19, we made 10 acquisitions, and they've contributed in part at various times over the course of this half.

Second thing to call out is finance costs, which you see are quite materially lower despite the acquisition profile, and that's largely, if not entirely, due to the benefits of the equity that we raised earlier in the year being offset against debt costs until that equity is fully invested. You'll see we spent $9.2 million on restructuring some interest rate swaps, and I'll talk about that in a little while when we get to the balance sheet.

And finally, and I'll also talk about this in the balance sheet, you'll see there's been a very small adjustment to the fair value that -- at which we carry our assets.

So distributable earnings on Page 17. So the first point to make here is that, as Margaret said at the beginning of the call, we've reconfirmed our guidance for the full year of between 3% and 3.75% growth on '18. So where are we today? You'll see we take a statutory net profit and we make the same sort of add-backs and deductions that we always have done in order to get to distributable earnings which represents, in my view, a reasonable proxy for the cash generated by the business from its investing activities, and we paid the distribution of $0.0718 per security for the half.

Looking at the balance sheet on Page 18. First thing to talk about is NTA. Now you'll see there's been a marginal decline in NTA over the period. So why is that? Firstly, we take quite a conservative approach to property valuations, and we've written off the acquisition costs to do with the acquisitions that we have made over that period. Secondly, we paid some money to restructure swaps. And thirdly, and looking back to property valuations, no independent valuations, apart from the things that we've purchased, were carried out during this period. So 1/3 of the portfolio will be independently revalued as at 31 December 2019. NTA per security is $2.18 and gearing at 33.4%.

Page 19 looks at capital management. Things to call out here are the leverage is at 33.4%, and we have $295 million approximately undrawn that we can use to fund various growth initiatives. So if we were to draw all of that money, and I'm not suggesting we will, but that would take us to a leverage of 40%. Against that financial capacity, as Margaret's mentioned, there's an attractive pipeline of possibilities that we are considering.

Coming back to the swap restructure. In June of last year, we restructured some -- sorry, we entered into some forward stock interest rate swaps which become effective in August of this year, so not in the current period but starting August. And we restructured those in the current period by paying a premium of $9.2 million. So in return for that, we will see interest costs improve by about 65 basis points effective August of this year. So that will improve the current half and future profitability.

I suppose in summary on financials. The FY '19 guidance has been confirmed, a growth of between 3% and 3.75%. We had no material change in property carrying values, but we have our independent valuations coming for 1/3 of the portfolio at 31st December and gearing at 33.4% with $295 million approximately of undrawn capacity and an encouraging pipeline to come against that.

So I will hand back now to Margaret. Thank you.

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Margaret Kennedy, Viva Energy REIT - MD [4]

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Thanks, Guy. As mentioned earlier in the presentation, our weighted average cap rate of the Viva Energy REIT portfolio is 5.8%. As you can see on the chart on Slide 21, which we've produced using industry data from JLL, the impact of decreasing interest rates, particularly over the last half, has seen the spread between the VVR portfolio cap rate and bond yields widen. The premium of the Viva Energy REIT portfolio cap rate to the 10-year government bond has widened from 3%, which was already healthy, to approximately 4.5% today. In this environment, the demand for service station and convenience properties with yields generally in the range of 4% to 7% with fixed rental increases remains strong.

Whilst Viva Energy REIT is not the operator of any of the sites, we're the landlord, from an underlying fuel and convenience business, we've seen growth in vehicle registration in Australia at approximately 2%, with diesel vehicles having increased from 19% of total vehicles to 25% at the end of 2018. You'll see this reflected through sales data such as the Toyota HiLux being the top-selling vehicle, followed by the Ford Ranger in 2018, according to carsales.com.

Premium locations with strong attributes and brands continue to capture the growth in convenience sales, with site profitability increasingly being attributed to convenience retail.

When we look at convenience retail store trends, the market continues to grow with in-store sales, excluding tobacco, growing at an industry level by 2.4% in 2018. That is also supported by the key category growth in fuel and beverage categories.

Viva Energy REIT's tenants are well positioned to continue to capture the growth of the convenience market, particularly with approximately 3/4 of our network located in metropolitan locations with close proximity to both passing, drive-up and walk-up trade.

As we move on to strategy and outlook, Viva Energy REIT is underpinned by strong real estate fundamentals in locations that are well known to many of you. Portfolio remains attractive and almost impossible to replicate with more than 300 of these properties in well-established metropolitan locations. They're supported by strong underlying real estate. We have more than 20 kilometers of actual street frontage and 188 corner locations in those metro areas. Our network truly is convenient. It's national, and we have locations within 5 kilometers of more than 70% of Australia's population. There are 166 sites on highways, with many of these sites incorporating new industry formats.

To touch on our competitive strengths, Viva Energy business -- the competitive strength of the Viva Energy REIT business is our market-leading national service station and convenience retail platform. As I mentioned earlier, it's underpinned by more than 2 million square meters of real estate with over 20 kilometers of street frontage and 188 corner locations in capital cities. We provide security of income through long-term triple net leases to high-quality tenants with 3% rental escalators and further opportunities to grow and enhance the portfolio through acquisitions and site developments.

The Viva Energy REIT business remains on track to deliver our 2019 guidance as provided in February this year of earnings growth of 3% to 3.75% over 2018. The pipeline for acquisitions remains strong, and we'll continue to deliver acquisitions in line with our strategy and investment criteria.

Our balance sheet's been restocked, and we'll maintain diversified funding and headroom with our current gearing being at the lower end of the range.

We have a busy second half planned for Viva Energy REIT and look forward to updating you at the end of the year.

That is the end of the formal presentation, and we're happy to take questions now.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Krzysztof Kaczmarek of JPMorgan.

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Krzysztof Kaczmarek, JP Morgan Chase & Co, Research Division - Analyst [2]

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Could you please just provide a bit more color on the acquisition and development pipeline? How much of that is going to fall into 2019, whether that's going to go into 2020? And what's the split between fund-throughs in sort of existing sites? Specifically, I'm sort of thinking, how much of that is going to be income-producing in 2019? And how much of that is going to be income-producing In 2020?

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Margaret Kennedy, Viva Energy REIT - MD [3]

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Thanks, Krzysztof, Margaret here. So without getting into the specifics of what that pipeline is in terms of specific assets, we are well advanced on a number of those assets. It will be a mix of property acquisitions at full trading sites and some fund-throughs. As to the specifics of that mix, it's probably not appropriate for me to give you the details on that at this stage.

You're right in terms of when income starts coming through. Anything, obviously, that we settle in the second half, you might see a full year's income on until 2020. And there will be some properties that will potentially settle late this year, some that might settle into early next year. So we don't generally give the specifics of that pipeline except to say that we've seen the demand for properties certainly increase postelection, and we've also seen the number of properties coming back onto the market increase somewhat since the election as well. So the team is very busy working through those currently.

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Krzysztof Kaczmarek, JP Morgan Chase & Co, Research Division - Analyst [4]

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Okay. And just a related question. You've sort of been historically guiding to around $50 million of acquisitions. I mean how should we be thinking about that going forward, both in terms of sort of the standard level of acquisitions that you're going to be doing year-to-year? And also, what is the sort of typical level of fund-throughs that you'll be doing going forward?

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Margaret Kennedy, Viva Energy REIT - MD [5]

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So we've actually never guided to $50 million. I think we sort of talked about it in terms of general. When we put our numbers out at the beginning of the year, for the capital raising, we guided $67 million in advance due diligence. And so I think if you look back, what we've done over the last couple of years, if the supervisors say past performance isn't necessarily the predictor of future, but the pipeline is well stocked, and there is good capacity subject to the right deals being on the table to sort of continue at somewhat a similar rate, albeit just a reminder as I said earlier in the presentation that even if we bought nothing, we still get 3% rental increase on more than 90% of that portfolio. As to the split, I'm not going to guide on that, because I couldn't give you that specific answer now anyway. The deals will come in and go out and will change accordingly.

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Krzysztof Kaczmarek, JP Morgan Chase & Co, Research Division - Analyst [6]

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And just one more for me, Are you getting any coupons on the development (inaudible)?

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Margaret Kennedy, Viva Energy REIT - MD [7]

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Absolutely. Yes, we collect that. Effectively from the time of settlement of the land, we are collecting a coupon. And for the ones that were outlined in that particular slide, we're collecting them at the same rate of 7%. We're not land-baking anything, Krzysztof. There's nothing that's not giving us a return.

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Operator [8]

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(Operator Instructions) Our next question comes from Peter Davidson of the Pendal Group.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [9]

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Just one for Guy, what's the WACC pay in the guidance for next year, Guy? What are you assuming in it?

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Guy Farrands, Viva Energy REIT - CFO [10]

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For this -- Pete, we haven't given numbers for next year. For this year, the cost has been 3.8% weighted average cost of debt. It will come down a little bit in the second half, because more of the funding will be variable rather than fixed but the business has quite a high proportion of fixed debt.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [11]

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Okay. And just one for Margaret, on the kind of retailer health, as it were, you can -- you gave us a number for in-store sales of slightly below the rental bumps. The growth I think was 2.4% for in-store sales. Can you just give us a number for fuel sales in dollars? Because obviously you're getting some sort of combination, different effects there. One of them is the move towards premiums, another one I saw is vehicle ownership, but another one is high fuel efficiency. So if you combine all that, what's the fuel sales numbers running at?

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Margaret Kennedy, Viva Energy REIT - MD [12]

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So on the convenience store stuff, we've given you, Pete, that's at an industry level, so that's not for our portfolio. So I think it's worthwhile just highlighting that that's the association of convenience stores. So that will include all the fuel-branded convenience stores as well as smaller and other brands as well.

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Pete Davidson, Pendal Group Limited - Head of Listed Property [13]

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So I get that you're always kind of above that, is that right?

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Margaret Kennedy, Viva Energy REIT - MD [14]

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Well, we don't get transparency on that data, Peter. So part of the way that we operate with Viva and our other tenants, and in fact, the whole industry operates, is you're not generally provided with data either on fuel or convenience store sales. So it's different from other retail where you might be seeing full transparency on sales. In terms of what's happening in the fuel market, the fuel guys, main ones I get to report.

So Viva, our tenant reports -- majority tenant reports on Monday. And Caltex, I think is -- not today, after today, sometime. So in terms of the overall market information, I think we'll certainly see that. Anecdotally, the market is pretty competitive at the moment. I'm sure that, that will be highlighted in some of the other presentations. But as a customer, you can see generally, certainly, where I'm driving around that the fuel market is generally pretty competitive.

Okay. I think that's the last question.

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Operator [15]

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There are no further questions at this time. So now I'll hand back to Ms. Kennedy for closing remarks.

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Margaret Kennedy, Viva Energy REIT - MD [16]

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Thanks, Carl. Thanks, everyone, again for joining us for our first half 2019 results. We look forward to catching up with you again soon and providing an update on the second half for you. Thank you.

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Operator [17]

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