Scentre Group (SCG) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Scentre Group 2022 Half Year Results Update. [Operator Instructions] Please note that this conference is being recorded today, Tuesday, 23rd of August 2022 at 9:00 a.m. Australian Eastern Standard Time. I would now like to hand the conference over to Mr. Peter Allen. Please go ahead.

Thank you. Good morning, everyone. I'd like to acknowledge the Gadigal people of the Eora Nation as the traditional custodians of the land I am on this morning. Recognizing that many of us are on different lands with different traditional custodians, I'd like to pay my respects to each of their elders past, present and emerging. Welcome to Scentre Group's half year results briefing. I'm joined today on the call by our Chief Financial Officer and incoming CEO, Elliott Rusanow; as well as Andrew Clarke, our incoming CFO. I'm very pleased to deliver today's strong results. Our team has continued to drive our business and deliver strong operational performance. We've grown customer visitation, portfolio occupancy, rental income and cash collection, resulting in strong profit growth for the half. Today's results highlight the quality of our portfolio and our continued proactive approach and operational excellence. Funds from operations was $548.6 million, up 18.3%. We are well positioned for growth, and I'd like to thank our team for delivering these results. Our ambition is to grow the business by becoming essential to people, their communities and the businesses that interact with them. During the 6 months to the 30th of June, the group completed 1,579 lease deals, including 585 new merchants, of which we welcomed 108 new brands to the portfolio. This has driven strong portfolio occupancy, increasing 30 basis points to 98.8% at the end of June. Our leasing spreads improved significantly to minus 3.9% in the first half of the year, and lease incentives remain in line with prior periods. We continue to maintain our standard lease structure with fixed base rent and inflation-linked escalations. Our average specialty lease terms have lengthened to 6.8 years. We continue to create the most productive and efficient platform for our business partners to engage with customers. Business partners generated $500 million more sales from our platform this half than the comparative period in 2019. Excluding travel and cinemas, total sales are $900 million higher than the 6 months to the 30th of June 2019. Total majors and specialty sales were 10.8% higher for the 3 months to June and 7.1% higher for the 6 months to June compared to 2019. Specialty sales were 13.7% higher for the 3 months and 8.1% higher for the 6 months compared to 2019. When we established Scentre Group in 2014, we established our purpose, creating extraordinary places, connecting and enriching communities. It guides to the delivery of our plan and our ambition and the way we lead our teams. We want to create destinations where people choose to spend more of their time. We continue to drive more visitation to our Westfield destinations. Visitation has increased to 277 million people of visits year-to-date, and we're on track to reach approximately 500 million visits for the year. We continue to make significant progress on our integrated strategic initiatives, which enhance our connection to and between our customers and businesses. Westfield Plus, our membership platform, has grown its membership to 2.75 million people, welcoming 550,000 members in 2022. We continue to deliver sought-after personal experiences that enhance our connection with customers and their experience across Westfield. We launched Westfield Direct, our aggregated click and collect service, in October 2021. It has experienced continued growth in customer advocacy and business engagement since. Westfield Direct now has 300 sellers and more than 325,000 products. And in the 6 months since launch, we have fulfilled more than 100,000 orders with the majority of these orders choosing to click and collect from their Westfield local center. Creating destinations to achieve our ambition drives our development opportunities. During the half, we opened the $55 million rooftop entertainment, leisure and dining precinct at Westfield Mt Druitt. And since opening, customer visitation and dwell time has significantly increased. The $355 million investment in Westfield Knox, Melbourne is progressing really well with strong pre-leasing and in line with budget. Stage 1, which will open in December '22, is currently 96% leased. The group continues to make significant progress on its responsible business initiatives across community, people, environment and economic performance. During the half, we released our 2021 Responsible Business Report, 2021 Modern Slavery Statement as well as our third Reconciliation Action Plan for 2022 to 2024. Earlier this month, we announced an agreement with CleanCo to source 100% renewable electricity to power our Queensland portfolio from 2025, consistent with our net zero target pathway. And we continue to make great progress on the integrated energy, water and waste plan. I'll now hand over to Elliott to take you through the financial results.

Thanks, Peter. Operating profit for the 6 months to 30 June was $541 million or $0.1043 per security. This is an increase of 17.5% over the first half of 2021. Funds from operations for the 6-month period was $549 million or $0.1058 per security, which grew by 18.3%. Our net operating cash flow after interest, overheads and tax was $570 million or $0.11 per security, growing by 16.9% compared to the first half of 2021. Our focus has always been on cash flow. Since June of 2020, our net operating cash flow has exceeded FFO. For the first half of 2022, net operating cash flow was $22 million higher than FFO. The group announced an interim distribution of $389 million or $0.075 per security for the half year, representing 7.1% growth. Since the start of 2020, the group has contributed $1.5 billion to securityholders and has retained $687 million of earnings. During the first half of 2022, net operating income grew by 6%. An expected credit charge of $14 million was booked relating to the financial impact of the COVID-19 pandemic on rental income during the 6-month period. This compares to the $45 million charge booked in the first half of 2021 and the $124 million booked in the second half of 2021. As indicated in our previous results, the pandemic has also impacted other revenue items such as car parking and ancillary income and extended downtime for opening of new merchant sites. During the period, we have seen these areas continue to recover. And for 2022, we expect to see ancillary income and extended downtime continue this improvement and to be within approximately $55 million of the pre-pandemic levels. During the 6-month period to 30 June, we collected $1.25 billion in gross rent cash collections. This represents an increase of $192 million compared to the second half of 2021. Included in our $1.25 billion collected to 30 June was the full recovery of the $185 million in trade debtors booked at the end of 31 December 2021. The net trade debtors after the expected credit charge provision at 30 June were $151 million, all of which relate to the 2022 billings. During July, we have collected a further $220 million. Operating and leasing capital was $56 million for the first half, and $12.4 million has been invested in our strategic customer initiatives Westfield Plus and Westfield Direct. During the half year, the group repaid $800 million of debt, including the early redemption of the GBP 400 million bond in January 2022. Also in January, we redeemed the $243 million Westfield Parramatta property linked note. In August, the group refinanced the $900 million syndicated bank loan facility. Due to strong demand from lenders, the facility was upsized to $1.1 billion, and the pricing of the facility of 142 basis points compares favorably to current bond market pricing. The $300 million secured bank facility in Carindale Property Trust was refinanced during the half as well as $1.2 billion of bilateral bank facilities. A total of $2.6 billion of new and extended banking facilities have been completed during the half. The group now has $4.8 billion of available liquidity, which is sufficient to cover all debt maturities until the fourth quarter of 2025. The average net interest cost for the half was approximately 4.2%. The group continues to actively manage its interest rate hedging position. During the half year, we have been deliberate in allowing our hedging position to reduce in the short term as contracts mature in order to take advantage of the lower floating interest rate environment. At the same time, we have increased our interest rate hedge coverage to 70% in January 2023 at an average rate of 1.99% and 67% at December 2023 with an average rate of 1.97%. In addition, given the current volatile interest rate environment, the group has taken the opportunity to put in place short-term interest rate hedging for the second half of 2022, providing the group with a greater level of certainty with interest expenses for the remainder of the year. The additional short-term hedging has resulted in overall hedge coverage of approximately 80% for the second half of 2022 at an average rate of 1.99%. This additional hedging was undertaken at no capital cost to the group. We retain our single A or equivalent ratings from S&P, Fitch and Moody's. The statutory profit was $480 million for the half, which includes the unrealized noncash increase in property valuations of $286 million. Approximately 50% of properties were externally valued during the half year, and the increase in value for these assets was driven by net operating income with minimal cap rate movement. We have provided on Slide 24 a summary of values by each property. The accounting stated net assets of the group is $3.67 per security and is $4.32 per security when the implied value of our property management income at the equivalent cap rate is included. Our business is in a strong position to deliver long-term growth by being essential to people, their communities and the businesses that interact with them. For 2022, the group expects FFO to be above $0.19 per security, subject to no material change in conditions. This would represent growth of more than 14.2%. Distributions are expected to be at least $0.15 per security, representing at least 5.3% growth. Before opening the call to questions, I would like to acknowledge that this is Peter's last earnings call for the group. I've tried to work out how many calls Peter would have now done during his career at both Westfield and Scentre Group, but I gave up trying. It's an enormous number. On behalf of the team, I would like to thank you for your tremendous leadership of Scentre Group since its inception in 2014. I also want to thank you for the positive impact you've had and -- you and your leadership have had both personally and professionally to so many, many people over the years. Thank you.

Thanks, Elliott.

I'd like -- on that note, I'd like to hand over the call for to questions.

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

Congratulations on your tenure, Peter. Just in terms of the comments you made, Elliott, just about the drag on ancillary income, can you spell out what the first half contribution was in ancillary income and what that was in the first half in 2019?

Yes. So the normalized number pre-pandemic is around 180 -- it's around $165 million.

Full year.

For the full year. During the half year of this year, the number was around $70 million. So on that basis, you can see where that drag is coming from.

Okay. That's helpful. And just in terms of project income, it wasn't a significant contributor in the first half. Is there more project income you'd expect to come through in the second half?

Yes. So during the half year, we recognized project income principally at Knox and Mt Druitt. During the second half of the year, we'll recognize more of Knox. Obviously, Mt Druitt is now completed and likely to start recognizing income from 101 Castlereagh Street.

Okay. And just in terms of what the guidance implies in your cost of debt, is there major changes anticipated in the second half?

So we've adopted the market curve, call it, as at yesterday or today, which would imply the BBSW 3-month, which is effectively our floating rate cost, increases to 3.3% by December of this year.

Your next question comes from Lou Pirenc from Jarden.

Yes. Can you talk about asset values? I mean, they haven't really moved much during -- or NPI didn't really move much. I mean, do you feel that valuers are still being conservative given the significant increase in rents? I mean, I do recall you wrote down your assets at the beginning of COVID. How should we think about that?

Yes. I think it's fair to say, Lou, that the -- there's an absence of market transactions, which obviously impacts how external valuers calculate their view of what the valuation should be. It's also fair to say that income has performed better in our results than what valuers had assumed in June of 2020 when the big write-downs did occur. They have taken a more conservative approach with regards to downtime, with regards to leasing spreads. And we -- as you can see from our results, we believe that our operating cash flow is showing better results than probably what the valuers have been assuming. The issue, I suppose, is in the valuation community, the impact of changing of interest rate environment. But again, in the absence of an external market pricing, it's very difficult for valuers to ascribe a value. All we can say is that our operating cash flow and what we're seeing at the -- from the operating metrics is better than what the valuers have been assuming.

Yes. I think the other thing, Lou, just to make a point, is that we've externally valued half of the portfolio, and the balance has remained flat, okay? So we haven't got that external -- and the internal value, we kept flat as where it was in December. So that has impact. The other thing is if you look at the cap rates which are being used, you'll see there's been no change in cap rates. So the growth has really come from the growth in income, which is a real -- to me, is a real positive sign. As you know, we're not driving the business in terms of the valuation growth. We're driving the business in terms of operational cash flow.

Makes sense. And then just to confirm, when you collect rents from prior periods to 2021, you don't include it in your FFO, right?

No. So again, there is a disconnection in, call it, accounting terms between cash and FFO. But in effect, when you look at over that extended period, cash has exceeded FFO, which is part of the reason why the trade debtor keeps reducing each accounting period. So just to be clear, no reversal of any provisions, all cash backed, and our cash collections remain very strong.

Your next question comes from Grant McCasker from UBS.

Thanks for providing FFO guidance. I think in the past or very recently, you sort of made some pretty clear comments to say that's not in the policy for Scentre to provide FFO guidance. What's changed there?

Well, I think, Grant, what we did say was that given the volatile environment that we have been in, particularly at the February results, it was very difficult. If you remember, at that time, there was another wave of the pandemic occurring. And we weren't in a position that we would provide guidance on an earnings level for a 12-month out period. As you know, we're at December year-end. So as we've gone through the year, as conditions from that pandemic have become clearer, as our cash collections have become very clear, obviously, with our result and continue to be, our operating metrics are performing very well, as Peter said, occupancy has increased, customer visitations have increased, average rent has increased, our standard leasing structure has not changed, and leasing spreads continued to improve, we're in a position where we can provide guidance, albeit our guidance is in the form of what we expect to be above rather than giving a hard guidance number that we're aiming towards, given that there is still a volatile environment out there, particularly with interest rates, as Richard asked before. And we'll know more as the months progress. But we're in a comfortable position now to provide, call it, a baseline of where we expect FFO to land.

Okay. Excellent. And just secondly, yes, you've done a lot of debt refinancing. They're showing a lot of support from the lenders. Your A rating negative interest cover, obviously as we move into '23, is probably one metric to consider. Is the debt levels appropriate for this current interest rate environment?

Well, I think, firstly, our rating is A, and it's stable from all 3 rating agencies. Interestingly, there's a lot of commentary in the, call it, equity land around our debt levels as a percentage of total assets. But the -- as I articulated, the cost of our debt is actually very competitive vis-à-vis other groups that might, on the face of it, have different gearing levels. So I'd just highlight that the support from the people who are actually providing the debt who do use credit ratings and do look at the debt levels on our balance sheet are willing to provide us with increased levels of debt at cheaper pricing relative to others. So we are comfortable with the current settings, and we'll continue to manage it through. I think importantly, we have sufficient liquidity now to cover us for all bond maturities and debt maturities through to the fourth quarter of 2025, which provides us with a lot of flexibility with respect to where we source capital and the pricing of where we source that from.

Your next question comes from Ben Brayshaw from Barrenjoey.

I was wondering if you could comment on the recovery in travel and cinema sales and what your expectations are for those 2 categories going forward.

Yes. So Ben, it's Peter. In terms of cinema sales, cinema sales are growing pretty strongly, as you would have been aware, with the movie releases that we've had in the first 6 months has been very strong. But they're still not back to where they were in 2019. They probably around the 80% mark to where they were previously. And travel is still growing, but it's still being limited by the availability of flights, both domestically as well as internationally. So the growth of travel, whilst it is growing, it is certainly far below where it was before. And I think if you look at the slides, you can see that cinemas and travel are up, what, about $200 million between the second half of -- the first half of last year and the first half of this year, which is a positive sign. But we're still nowhere near where we were back in 2019.

Your next question comes from Simon Chan from Morgan Stanley.

Your guidance of $0.19 -- sorry, more than $0.19 implies second half FFO of about $0.085 after you guys having achieved $0.106 in the first half. What's the reason for that step-down? Is it purely the floating rate impact?

Well, I think there's a combination of things. Firstly, it's above $0.19. So I wouldn't go into the implications of what second half looks like versus first half necessarily, so just bear that in mind. But there are, as you point out, changes in certain line items, particularly, as you pointed out, the interest rate line, which we did see the benefit of, very low interest rates in the first 6 months of the year. We've been very deliberate with that strategy. But we have locked away a lot of that, call it, risk -- expense risk on the interest line for the second half of the year, which has given us more [ $0.17 ], being able to provide the base level of guidance for FFO for the second half. So in terms of that line, that's pretty clear. Now as I said, we've assumed that the current floating rate gets to 3.3% by the end of the year, which is the current market curve. But clearly, the other line items that will move is we anticipate that occupancy will continue to increase. We continue to expect that rental escalations will continue that momentum, but one big variable is going to be what the inflation rate is for the third and fourth quarter of this year. So there's a lot of variables in that number, which is why we've given a baseline which we expect to beat.

Great. And my second question, Elliott, just on Slide 10, I don't mean to be nitpicky in what's a good result. But if I'd just be very simple and look at the property revenue line 6 months to '22 versus 6 months to 2021, it's only up by like barely 2%, notwithstanding all your CPI impact, occupancy increasing, et cetera. Like why is there a mismatch?

Yes. It's a good question, and the answer to that is that the expected credit charge is booked after the revenue. So in effect, we book the revenue as if we're charging and collecting the full rent, knowing that the code was in place in 2021, which meant that we then booked an expected credit charge after that revenue line. So net of the expected credit charge, you'll see that net operating income grew by actually 6% year-on-year for that 6-month period.

Your next question comes from Louise Sandberg from Bank of America.

Just a quick question. Your hedging at 80%, that excludes the subordinated notes. Is that correct?

No. It doesn't. It's 80% of, call it, total facilities, including the subordinated notes, yes.

Okay. Awesome. That was my...

Drawn facilities.

Your next question comes from Sholto Maconochie from Jefferies.

Congrats on a good result. Just on Channie's question, if you look at that slide, if you back out the ECC, like it looks like the revenue went up 2.4%. And ex ECC, the NPI is only up 2.3%. Is that just because -- it just doesn't seem like it's a big improvement. It seems like the growth was really driven from the sort of write-back of the lower COVID charges. Just trying to understand why there was only sort of 2.4% growth.

Yes. So Sholto, there's 2 other things to note. Firstly, that Knox is -- has downtime. Obviously, it's not adding as much income for that development compared to, what, 2021. That will come back in stages from December of this year. And secondly, the timing of escalations with regards to CPI flows through the year, it doesn't occur at the very beginning of the year. So -- yes.

Yes. So you should see a pickup in the -- for the second half, you get -- because the -- so you do it on a rolling basis. You should see a pickup in the escalator in the second half because of that, which gets a bit offset by the debt. Okay. That makes sense. And then just on the hedging in your update in, I think it was May or -- in your Q1 update, you had hedging. It's -- you increased it, I think, 65%. Now it's gone up. So you've entered into more hedges post that update in the quarter, the first quarter update. Is that correct?

Yes. We principally did that when the market, if you remember, the interest rate markets started pulling back. With interest rates going down, we took advantage of that moment in time to lock away more of our interest rate exposure for the remainder of this year and increase it slightly for the duration of next year.