Scentre Group (SCG) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to the Scentre Group 2019 Full Year Results Update. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, the 18th of February 2020 at 9 a.m. Australian Eastern daylight savings time. I would now like to hand the conference over to your host today, Mr. Peter Allen. Thank you, sir. Please go ahead.

Thank you. Good morning, everyone. Welcome to our results briefing for the full year ended 31st of December 2019. Presenting with me on the call this morning is our Chief Financial Officer, Elliott Rusanow. Also joining us in the room is our Director of Leasing and Retail Solutions, John Papagiannis; Director of Customer Experience, Phil McAveety; Director of Development, Stewart White; and Director of Design and Construction, Ian Irving. I'm really pleased to report our financial performance for the year was strong with FFO growing by 3.2% on a pro forma basis, and distribution has grown by 2%, both in line with forecast. We've delivered what we said we would because we have remained focused on our customers and continue to curate our offer to keep pace with their changing expectations. Retail and change go hand-in-hand, and changes are constant in our business. We adapt to what our customers want and have been at the forefront of change in our industry and market for more than 60 years. Our purpose is creating extraordinary places connecting and enriching communities. During the year, we updated the way we describe our company's strategic objective, which we call our plan. It's simple and it's clear. We will create the places more people choose to come, more often, for longer. Our strategy is based on the fundamental principle that we compete for the time and attention of our customers. Our strategy reinforces the competitive advantage we have in the location of our Westfield Living Centers in densely populated urban areas, close to where people live and work and embedded in the heart of the communities. Our business is unique in that we cater to our customers throughout their lives, and our relevance to them changes at each life stage. Execution of our strategy focused on 4 key stakeholders: Our customers, we'll be customer-obsessed, delivering extraordinary experiences every day; our retail and brand partners, we'll be true business partners for our retailers and brands to maximize their opportunity to interact with customers; our people, we'll be the place for talent to thrive; and our investors, we'll deliver long-term sustainable returns through economic cycles. The strength of our portfolio and source of competitive advantage for our leading operating platform is executing a customer-focused strategy and consistently delivering results. Annual customer visitation increased by 12 million during 2019 to more than 548 million, and our occupancy remains high at 99.3%. We are the leading platform in Australia and New Zealand for retailers and brands to interact with consumers. In-store sales on our platform are now $25 billion and continue to grow. Our retail in-store sales represent more than 7.5% of total retail sales in Australia. We have 3,600 retail and brand partners, represented more than 12,000 outlets across our portfolio. The average annual specialty in-store sales across our portfolio is $1.525 million per store. By listening and acting on what our customers want, we have actively curated the mix within each center of our portfolio. During the year, we introduced 344 new brands to our portfolio, and 279 existing brands grew their store network with us. In recent years, this has been seen through the shift towards experiential retail and consume on site, which continues. Today, 43% of the stores in our portfolio are experience- and services-based. Customers continue to want a seamless shopping experience. We see this as an opportunity and believe that physical retail is and will remain a central part of the retail ecosystem, key to retailer sales and distribution strategy. This is based on the fact that well-located, high-quality physical retail, like our portfolio, is the most cost-efficient means for a brand to engage with the customer. It's also difficult to replicate. We continue to innovate in how we engage with our customers to leverage this opportunity. New technologies are providing more opportunities to enhance our direct engagement with the customer. As part of the launch of Westfield Newmarket in New Zealand, we developed and launched Westfield Plus, a mobile app-based membership program. More than 200,000 customers in New Zealand have downloaded the app since August. And this has provided us insights into how we might introduce a similar initiative throughout our business in Australia. We also continue to see increased investment in click and collect as retailers can seek to optimize their store networks and close proximity to customers. Much is made about the growth in percentage terms of online versus physical sales. However, in dollar terms, over the last 3 years, physical sales in Australia have grown by $15.8 billion, 62% more than the online sales growth of $9.7 billion in the same period, of which over 2/3 is from multichannel retailers with significant physical store presence. We had a busy year last year. And during the year, we completed the NZD 790 million Westfield Newmarket development on time, creating the leading lifestyle and fashion destination in New Zealand. We are reinvesting in our portfolio and have commenced a number of projects that will improve the offer and experience for our customers. This includes the $50 million project in Westfield Carindale, which now includes a new David Jones, which opened in November; and the introduction of Kmart, the most wanted retailer as far as Carindale customers are concerned. Opening mid this year is our $55 million dining and entertainment precinct at Westfield Mt Druitt, adding 12 new rooftop restaurants. And we have $89 million of special projects underway more recently completed including the Bradley Street dining precinct of Westfield Woden and the expansion and refurbishment of the dining precinct of Westfield Doncaster. Capital management continues to be a priority for the group. In 2019, we released $2.1 billion of capital through the divestment of the Sydney Office Towers for $1.52 billion, and the joint venturing of Westfield Burwood with $575 million. The capital release from these transactions is being redeployed into our business. In late 2009, we acquired a 50% interest in Westfield Booragoon in Perth for $570 million, becoming the long-term manager and developer for that center. Westfield Booragoon's strategic location and high quality make this acquisition entirely consistent with our strategy. We also commenced our buyback program of up to $800 million and, to date, have bought back $304 million of securities. Underpinning our strategy is being a responsible and sustainable business. Our sustainable business framework is built on 4 pillars: our communities, our people, our environmental impact and our economic performance. We are pleased to have sustained a high employee engagement rate of 84% in our most recent engagement survey, which places us in the top 2% of companies globally. We've recently been included in the 2020 Bloomberg Gender-Equality Index, acknowledging our focus on talent, diversity and inclusion in a global peer group. We are committed to operating an efficient and resilient business for the long term. We have existing environmental targets for emissions intensity, waste and recycling that our teams are making really great progress on. In addition to this, the group today announced it will target net 0 emissions across our wholly owned portfolio by 2030. Work will continue this year to align existing initiatives to this target. Earlier this year, we partnered with the Salvation Army as part of our response to the bushfire emergency by way of a cash donation of $0.5 million and providing significant in-kind support through our digital screen and media networks across our platform to expand the reach of their message and facilitate further fundraising. We will continue to support the efforts of the Salvos as the long-term recovery and resilience work is undertaken across the country. Full highlights and performance data across our 4 pillars will be presented in our standalone responsible business report at the end of this first quarter. I'll now hand over to Elliott to take you through the financial results and outlook.

Thanks, Peter. The strong operating performance underpins the group's FFO of $1.345 billion or $0.2542 per security. FFO per security is up 0.7% or 3.2% on a pro forma basis and is in line with forecast. Pro forma FFO adjust for the transactions completed during the year, including the sale of the Sydney Office Towers in June 2019; the 50% joint venture of Westfield Burwood also in June; the acquisition of 50% of Westfield Booragoon in December; and the $304 million of securities bought back during the year. Operating earnings, which is FFO before project income, was $1.287 billion and up 3.6% on the same pro forma basis. Operating earnings for the period included growth in comparable net operating income of 2%, with continued increases in average rents across the portfolio and the maintaining of high occupancy levels. Rental growth was primarily driven by contracted annual rental escalations of approximately 4% for specialties, combined with specialty leasing spreads on approximately 20% of specialty tenants of minus 5.5%. Earnings were also positively impacted by the contribution of the recently completed developments at Westfield Newmarket and Woden. Earnings also include the impact of active development work at Carindale, Mt Druitt, Doncaster and Belconnen together with the impact of predevelopment work at Knox. Project income after tax for the full year was $57.2 million compared to $59.7 million in 2018. Project income included contributions from joint ventured assets being: the completed Newmarket and Coomera developments; the active Carindale project; and a number of special projects and capital works. Overhead were $88 million for the year with growth from 2018 of approximately 2.5%. The growth in overhead is related to our continued focus on investing in data and technology to innovate how we engage with our customers and enhance the customer experience. Statutory profit for the 12 months was $1.18 billion, including asset revaluations during the period as well as mark-to-market adjustments on financial derivatives and the capital gains from the joint venture at Westfield Burwood and the disposal of the Sydney Office Towers. Cash flow from operating activities was $1.323 billion. Adjusting for changes in working capital, cash flow is in line with FFO. The distribution for the full year was $0.226 per security, an increase of 2%, also in line with forecast. During the period, we announced a security buyback program of up to $800 million. $304 million of the program was completed during 2019, and we intend to continue executing the remainder of the program. The group's financial position remained strong with FFO to debt of 10.3% and interest cover of 3.6x. Our balance sheet gearing was 33% at the end of December. It is worth noting that our balance sheet does not ascribe any value to the group's unique operating platform, which generated more than $215 million in 2019, equivalent to 16% of our FFO. The group has A-grade credit ratings from S&P, Fitch and Moody's. We also continue to maintain high levels of liquidity with undrawn committed facilities and cash totaling $1.8 billion. The group continues to have a diversified source of funding, with 64% of our funding from long-term bonds and 36% from bank facilities. Our debt maturities extend until 2029 with a weighted average debt maturity at 4.2 years. Our interest rate exposure was 85% hedged at December 31. The average interest rate on our debt for the 12 months was 4.2%. During 2019, we invested $113 million in operating and leasing capital. This amount includes strategic capital invested to introduce a number of leading retail partners and for existing key retail partners to grow their store network across our portfolio. On average, leasing capital represents approximately 7.2% of total rent over the term of the lease. We maintain a very disciplined approach with regards to leasing capital. In cases where it forms part of the lease, the capital is used in contributing to the investment our retail partner makes in fitting out their store. This is an important distinction because by directing the capital in this way, we benefit from the high-quality store the retailer opens in our center to interact with the customer. This enables us to continuously curate the retail product and service offerings. Importantly, it also improves the ambience of our Westfield Living Centers, creating places that our customers want to come. As part of today's release, we have included our property compendium for 2019. The compendium includes key metrics for each of our assets, including demographic information, annual customer visits as well as retailer sales productivity. These are the key performance metrics that we utilize. We have also continued to include, as we have in previous periods, the book value for each asset as well as the sales per square meter for stores less than 400 square meters in area. Turning now to the outlook for 2020. Operating earnings are expected to be between $0.2475 to $0.2480 per security. This would represent pro forma growth adjusting for the full year impact of the transactions completed in 2019 of approximately 3.1%. Included in this forecast is comparable net operating income growth of approximately 2%, which takes into account the lower inflationary environment. Project income after tax is expected to be approximately $28 million in 2020 compared to $57.2 million in 2019. This change in project income is simply a function of the amount of project work currently underway at joint ventured centers. The group's forecast FFO, being the combination of operating earnings and project income after tax, is expected to be approximately $0.2530 per security for 2020. This forecast, however, does not include the expected positive impact from completing the remainder of the security buyback program. Given the asset transactions completed in 2019, together with the completion of a number of major development projects in recent years, the group is in a position to align the growth in distributions to growth in operating earnings. The group expects to retain approximately 7% of operating earnings and 100% of project income earned each year. Accordingly, distributions for 2020 are expected to grow by 3% to $0.2328 per security. I would now like to hand back to Peter to conclude.

Thanks, Elliott. To be successful in today's market, you need to have your eye firmly on your customer and stay close to their changing needs and preferences. Our ability to better understand what our customers want has secured a strong position for our business. Our proposition is to deliver long-term sustainable returns through economic cycles. We will continue to adapt, grow earnings and distribution and deliver on our purpose, creating extraordinary places, connecting and enriching communities. I'll now open up the call for questions.

[Operator Instructions] Your first question comes from the line of Richard Jones from JPMorgan.

Just in regards to the dividend policy, is that an FY '20 policy? Or is it an ongoing policy from now?

Richard, yes, it is for 2020, but the expectation is it will continue in the future that our distribution will grow in line with our operating earnings.

Okay. And then just in terms of guidance, I'm just a little bit surprised the growth is not a bit stronger given, obviously, the impact of a full contribution of debt-funded Booragoon and, obviously, the completion of Newmarket. Can you talk about some of the factors other than, obviously, project income that you've called out that are perhaps dragging on the growth, maybe with respect to downtime incentives perhaps?

Yes, I don't think there's any real change in downtime on incentives. I think that what you're looking at is with Booragoon, as you say, if you look at the -- it being debt funded, you've got to look at the overall cost of our debt. And given that we're highly hedged, I think we're about 85% hedged at the end of the year. Our average interest rate, as Elliott said, for the last year was 4.2%. I don't think that it's going to come back down that much for 2020. So that -- so the Booragoon this year is that. As far as Newmarket is concerned -- so therefore, the difference in terms of the yield, which we bought Booragoon at given it had approximately 30 vacancies from when we bought it, which we've got to lease-up, I think our initial yield was somewhere in around about 4-and-a-bit percent, 4.7%. And then -- and our average cost of debt, as I said, is about 4.2%. With respect to Newmarket, as you know, we opened Newmarket in August. We'll have the second stage open the end of the year. We still got the luxury areas open in that stage. And so that is going to be some downtime in terms of being able to be in a position to achieve our stabilized yield. So that will take some time, and I would not expect to see all of that luxury open until probably the third quarter of 2020. So that's probably the 2 key areas.

Okay. And as we go into 2020, Peter, can you talk about, obviously, you've made a few transactions throughout the course of the year, do you think you're more likely to be on the buy side or sell side in 2020? And I think you called out the buyback would be back active.

Yes. So as you know, being in the blackout period, so I haven't been able to exercise the buyback. But as Elliott said, the numbers are there, which I'm assuming no additional buyback. However, we have the objective to go into the market and fully utilize that buyback. We see that as the best investment of our capital at this point in time given that we're really focused on owning and operating the best centers in the best markets. And as I said, with regards to where our location of our synergies, we're in very-high dense locations, heart of the communities. There are very few opportunities for us to be able to grow our business through acquisition. However, earlier -- last year, we probably didn't think that the opportunity of Booragoon would come about, which it has, and we've been able to be successful there in expanding our footprint in Perth. So I think that where we are present is that we're currently very happy with the centers which we currently own. We're certainly out there and looking at if there are opportunities for us to be able to expand our business through acquisition of the other better centers. And we've only got, I think, what, 8 of the top 10 centers in terms of total sales is concerned. So there's very few if we're going to be focused on what our strategy is. We will be continuing to reinvest in our centers, and that's not just large projects, but even some of the smaller projects. Some of the benefits that we've seen through the small examples that -- Plenty Valley, Tea Tree Plaza, in terms of the cinemas and the restaurants, has really enhanced the way that those centers are engaged within their local communities. So I think you'll be seeing a lot more of that going forward.

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

Firstly, thanks for the additional disclosure in the property compendium, it's really helpful for us. My first question has to do with just foot traffic, et cetera. Just with the global health issues, just wondering if you've seen any change in footfall across your centers and impact on luxury tenants, leasing impact, et cetera?

Yes, Simon, just your first preface, I think we are providing the same information as what we provided in the property compendium last year, so there's no real change there. But in terms of what we're seeing from the virus, I think we've got -- it's very early for us in terms of saying what the impact is on our centers. As you know, most of our sales are local in terms of the way that our centers operate. I think even our luxury retailers are talking about here in Westfield Sydney, approximately 80% of local rather than tourists, but we're not necessarily seeing a change at this time. And as I said, it's too early to tell when you look at foot traffic across our centers. There's a lot of variation to what happens with foot traffic. And we've got a few other issues, whether it's the change in timing of Lunar New Year. I think this year was early February. Last year was late January. 2 weeks again -- 2 weeks ago, we're inundated by storms, which had an impact. I think the week before that was 36 degrees and a lot of people down the beach. And what we're trying to do, as we said, is we're competing against for people's time. And so, yes, we're in the long-term game as far as what we're doing and our retailers are certainly in a long-term game. But at this stage, it's a little bit too early to tell, Simon. And Simon, the other thing, which I think I should say is that what we've seen certainly is the continuation of sales across our portfolio. We've got in the numbers for January, and our specialty store sales, comparable sales for January compared to January last year was up 3% in Australia. So yes, that's pretty pleasing.

Yes, sounds good. And just on your development slide, the special projects in total, $89 million, do they also have a target yield on cost of greater than 7%? Or do they kind of come under a different bucket?

They come under a different bucket, Simon. It's really dependent on in terms of we're trying to maximize the return out of it. But given that they are special projects, there are more enhancements there, but we certainly do get a yield above the cost of funding in terms of those projects.

Fair enough. Can you perhaps give us a bit of an update as to WA, then? You just bought Booragoon, but I can't seem to find any details in there as to your development kickoff. And also Stirling, that had been in predevelopment for a little while. And now that you've deferred it, are you going to do anything to improve the center over there temporarily?

Yes. So with regard to Innaloo, as I said, when we announced the acquisition of Booragoon we said that we're going to delay the Stirling project, which -- and we are now focused in terms of Westfield Innaloo in terms of making sure that it really makes this market. We are holding a lot of those retailers in for that predevelopment work. So again, our focus is what can we do with that property now. As far as Booragoon is concerned, we're working closely with AMP as well as the local authorities in terms of putting forward plans to be able to expand that. So that's, I mean, something which will not start in 2020 but probably, certainly, maybe like '21, '22, in that time frame.

Okay. And just the last one for me today, Peter. Newmarket, I noticed in your answer to Jones' question that the luxury precinct went up until the third quarter this year. I thought the target was by end of 2019. What was the reason for this slight delay?

Yes. So when we originally set up Newmarket, we had the expectation that Newmarket would be fully complete by the end of 2019, and that we have big 3 stages of opening for that. What we found is that we made a decision early on in the piece that there is real opportunities for us to introduce luxury and in a consistent basis. As you're probably aware, in Auckland, it's pretty all over the place as far as the city is concerned, and it's not conducive for luxury to be able to be aggregated. And so we saw this as a unique opportunity for us to be able to take advantage of Westfield Newmarket. So we, in effect, through the projects have kind of changed our -- part of our design in terms of what we're doing on the David Jones' end together with going out and targeting a number of the luxury brands. And as you probably are aware, the luxury brands probably take a little bit longer to finalize lease transactions. They are very much set in their own ways as when they want to open their stores. It's very difficult for us to be able to set a time table for them to open. And I think the unique thing about Westfield Newmarket is it's the first project that we've opened where in terms of more locations -- in this local location, where we've got luxury opening. And that's really unique in having that. And we will hopefully be able to get some of these luxury opened before the first half of this year. But as you mentioned, we're working as hard as we can. But yes, we're investing in these centers for the long term. It's not just the short-term basis. We're investing for the long term. We believe having the luxury is going to really identify Newmarket as the key place for customers to visit in now in Auckland.

[Operator Instructions] Your next question comes from the line of Adrian Dark from Citi.

Peter and team, could we just go back to the payout ratio and get your thoughts in a little bit more detail on that, please? I think the plan previously had been to bring that down to 85%. And this year, we're looking at 90%. So that's a reasonably material change and obviously a change in direction. Could you just talk us through the rationale for that, please?

Yes. It's not probably a change -- it's Elliott here. I think that when we look at the entire capital mix -- and so we obviously did a bunch of transactions last year. We released $2.1 billion of capital. We're in the process of returning part of that capital through the $800 million of buyback. We made, obviously, some strategic capital acquisitions -- or acquisition during the year being Booragoon. When we look at the entire funding mix and our likely development expenditure as we go forward compared to where it's been in the previous 5 years, we believe that we're in a position to align the growth in our distributions towards the growth in operating earnings and use that as the basis of how we pay out distributions moving forward. Bearing in mind that as project income is a volatile line item, we will be looking to retain 100% of that and not distribute any of those proceeds out, so that's effectively the change.

Okay. And then in terms of the balance sheet, I think gearing is at 33%, the buyback would obviously tend to increase that. And it looks like valuations have turned slightly negative in the second half of the year. Could you talk about where you see gearing heading given your plans for the business, please?

Once again, the -- so with regards to valuation, it didn't affect the valuations themselves, relatively flat. What you're seeing there is the movement in effectively maintenance and leasing CapEx that goes through and is expensed effectively in the revaluation line in the main. There's obviously ups and downs that go into that. But in totality, the valuations are relatively flat. I think that as we look at the investment of capital, we actually are far more focused on, as you know, cash flow metrics as a determinant of balance sheet strength. We obviously had very high FFO to debt ratio of 10.3%. So we see it as a far more relevant measure than gearing being a percentage of total assets, which, as I pointed out, doesn't actually include the value -- any value for our operating platform. Having said all of that, obviously, gearing will increase in the absence of movements in valuations, but we still see it being below that 35% level that it has historically been.

Okay. And just finally for me, in terms of the development pipeline, it sounds like you're expecting the level of activity in that to be lower in the future. I think in the past, it's run at somewhere in the order of $600 million to $700 million on a sort of all-in basis. Do you have a figure in mind on a go-forward basis, please?

Adrian, it's Peter. It's really hard to kind of set that out. I think if you go back 5.5 years ago when we set out at Scentre Group, we were talking about the fact that our development would be volatile, and probably we see volatility in our project profit line depending on which projects we do and whether they were joint ventured or not. What we have seen, though, is the complete opposite. We're seeing a consistent, basically, project profit line, together with consistent probably $400 million of our share in terms of capital we invest. I wouldn't be surprised if that overall would continue going forward. It just may be a little bit more lumpy depending on the size of the projects. And it may not necessarily be large projects, it could be the aggregation of a number of the smaller special projects, which bring that forward. But the 2 key projects, which we're working on today is market straight in terms of the city with the expansion of Westfield Sydney, together with our Westfield Knox down in Melbourne. So they are the 2 key projects, which we're looking to start in 2020.

Your next question is from the line of Sholto Maconochie from Jefferies Australia.

Just a few for me, most have been answered. Just on -- and you can correct me, the maintenance and leasing effect was about $113 million, so basically flat year-on-year?

That's correct.

Okay. So we put productivity not cost in the compendium. And just on Carindale, you've obviously used -- you creeped up in the half to 62.6%. And there's 50% stake on the market trades at 28% discount to NTA. Obviously, it's more attractive buying a market. What is your view on Carindale and asset values more broadly?

Yes. So with Carindale, we're very pleased with our investment in Carindale. We see the asset very strong. It's got long-term opportunities in terms of growth. It's currently the second highest sales productivity center in Brisbane. As you said, we own 60-odd percent of Westfield -- of Carindale Property Trust, either we'll pay up for the owner of the other 50% of the asset. And you would have seen that they've got that asset out from the market. And so that's something which we'll evaluate, but probably nothing more I can add at this time, Sholto.

Okay, cool. And then just on the development pipeline, you probably start those projects, commence them in second half '20, just for timing purposes?

Yes, certainly. Well, certainly, David Jones, I don't believe market straight until the end of the first half of this year, so it will be later in 2020, and likewise with Knox.

Okay, great. And then on the valuations that you reported flat to slightly down, what are valuers -- assuming on sort of cap rates as sort of broadly flat in NTA? What are sort of the valuers looking at when they look at the asset values given where you're trading at and where recent transactions have been at?

Well, I think that what they do is they look at the recent transactions. There's been quite a number, whether that was the sale of the joint Marion interest by APPF, whether it was the joint venture at Burwood, so there's been some large transaction -- even Booragoon in terms of the acquisition of 50% of Booragoon, which include the management. So there's been a large number of large transactions last year compared previous -- compared to previously. What we are seeing generally, though, is that in this low interest rate environment, the valuers are probably keeping a similar level of discount rate, but also making an assumption of lower levels of growth going forward as far as rental income is concerned, which is saying that whilst we're seeing growth in rental income going forward in terms of our assets, we're not seeing that reflect in terms of the asset value because the asset values are remaining constant.