Welcome to the Charter Hall Retail REIT (the REIT or CQR) 2020 Annual Report.
2020 has been a challenging year for the retail sector. The financial year began with a backdrop of sub-trend economic and wages growth. Against this backdrop, drought and a terrible bushfire season ravaged much of the country, providing significant hardship for many Australians. In isolation these events would have marked FY20 as a challenging year, but all this took place before the COVID-19 global pandemic.
The impacts of COVID-19 have been significant and continue to be felt today. In late March, the Federal Government mandated store closures for many of our speciality tenants and restricted trading conditions for others. In April, the Federal Government introduced the National Cabinet Mandatory Code of Conduct (Commercial Code), which provided a framework for landlords to work with their small and medium enterprise (SME) tenants to provide rental relief. These moves were unprecedented and provided significant challenges for landlords and retailers. However, it has been this environment that has demonstrated the resilience of the CQR portfolio.
CQR’s focus on being the leading owner and manager of property for convenience retailers saw our centres remain open during the during the crisis. This was due to being classified as essential services, thereby highlighting the important role our centres play in servicing local communities. This was evident with increased trading volumes and footfall for supermarkets, fresh food and service categories such as pharmacy. The non-discretionary nature of the majority of our retailers also meant that tenants representing approximately 87% of portfolio income were open and trading throughout the worst of the Government mandated shutdowns.
CQR in partnership with our tenant customers has proactively managed social distancing measures and government regulations with a priority on the health, safety and wellbeing of our communities and those who work in, and visit, our centres.
CQR recognised the importance of partnering with our tenants in these challenging times to ensure long-term sustainable outcomes for both our tenants and unitholders. CQR has also provided support to our most affected speciality tenants under the terms of the Commercial Code. This saw CQR provide $10.7 million of COVID-19 rental support, equivalent to 4% of annual income, by way of rent free incentives and deferred rent. This also provided an opportunity to extend leases and look for mutually beneficial outcomes with our tenant customers. Importantly, our major tenants Coles, Woolworths, Wesfarmers, ALDI and bp, who collectively represent over 51% of portfolio income, continued to remain open for trade through the pandemic period and did not require any rental support.
The resilient nature of the CQR portfolio has seen this support progressively reduce from a peak in April to a more modest position in June as customer footfall and trading in our centres recovered. Reflecting this resilience, rental collections, after COVID-19 rental support adjustments for the period, had reached 97% for Q4FY20 by July. While we expect we will need to provide some retailers additional support in FY21, we forecast that this will progressively reduce, reflecting the high proportion of tenants across the CQR portfolio providing nondiscretionary goods and services.
Enhancing portfolio quality
Our transactional activity this year continued to enhance the portfolio quality by recycling out of lower growth properties into high growth properties and focusing on growing the resilience and defensiveness of CQR’s income.
Over the year, we divested nine lower growth assets and acquired interests in Pacific Square, Maroubra, Sydney and Bass Hill Plaza, Bass Hill, Sydney. These two convenience-plus assets each have multiple supermarkets and are well located within metropolitan Sydney. They also benefit from being the dominant convenience centre in their respective catchments and present strong income growth prospects for CQR. These transactions align with our approach of curating a portfolio of centres in growth markets that are the leading convenience centres in their respective catchments.
FY20 also saw CQR undertake a major new investment into the bp portfolio partnership to acquire a 47.5% interest in a portfolio of 225 long WALE convenience retail properties.
The portfolio consists of the majority of bp’s owned convenience retail properties in Australia. The portfolio is geographically diversified across seven Australian states and territories with 80% by value located on the eastern areas and 87% in major metropolitan locations. This portfolio is a capital efficient investment for CQR unitholders with the leases being ‘triple-net’, meaning bp Australia is responsible for all outgoings, repairs, maintenance and capital expenditure associated with the properties. The lease terms for bp Australia range between 18-22 years, with an average initial lease term of 20 years and annual uncapped CPIlinked rental escalators with a zero floor. Importantly, bp Australia continue to own a 51% interest in the portfolio and are also responsible for all environmental remediation issues associated with these properties, limiting CQR unitholder exposure to any environmental risks.
We see these Long WALE Convenience Retail properties as highly complementary to the existing CQR portfolio of convenience and convenience-plus shopping centres. The bp portfolio provides CQR with exposure to the large and evolving fuel and convenience retail market. Convenience comes in many forms for consumers today, and this segment of the market continues to grow as a channel for essential goods and services. Globally, bp is also a leader in fuel alternative investments and in the provision of fast charging infrastructure for electric vehicles. We are excited to be partnering with them.
Partnering with our major tenants
CQR’s strategy is to provide investors with a resilient and growing income stream by being the leading owner and manager of property for convenience retailers. Central to this strategy is partnering with major convenience retailers to meet their property needs across their value chain.
Our major tenants include market leading businesses Woolworths, Coles, Wesfarmers, ALDI and bp.
We continue to actively manage the portfolio to increase the percentage of CQR’s earnings from our major tenants, improving the resilience and dependability of income for CQR unitholders. We’ve been active in reshaping the portfolio to deliver this, increasing the percentage of major tenants’ income from 46.4% of portfolio income in FY19 to 51.4% in FY20.
During the year we completed six supermarket lease extensions and increased the number of ALDI stores in the portfolio from nine to eleven.
Post balance date, we further extended our partnership with Coles Group with the acquisition of a 52% interest in a $215 million high quality, purpose-built distribution facility fully leased to Coles.
Coles has a remaining lease term of 14.5 years plus multiple options and the lease has fixed annual rental escalations of 2.75%, providing a resilient and growing income stream for CQR unitholders. The distribution facility is located in Adelaide’s prime industrial precinct of Edinburgh Park, South Australia, approximately 25km from Adelaide CBD. The facility plays a key role in Coles’ supply chain, servicing all of its retail stores in South Australia and the Northern Territory. This acquisition extends CQR’s relationship with Coles from supermarkets to providing the critical infrastructure that supports their supermarket network. This forms an important part of our strategy and provides significant opportunity to participate across the value chain of our major convenience retail tenant partners.
Strong operating performance
Supermarkets remain the foundation of our portfolio. While the total number of shopping centres owned by CQR reduced by seven this year, the number of supermarkets in the portfolio remained constant at 70, a reflection of our emphasis on acquiring centres with multiple supermarkets that dominate their catchment.
Our portfolio of supermarkets delivered strong MAT sales growth of 5.2% over the period. The total number of supermarkets paying turnover rent was 61%, a record high for the portfolio and a result of the ongoing portfolio curation. A further 17% of supermarkets are within 10% of their turnover threshold, indicating good potential for future rental growth.
Despite the challenging retail conditions, we completed 345 specialty tenant leases during the year and saw positive leasing spread of 0.9%, with new leases 0.5% higher than previous leases and renewing leases 1.1% higher than expiring leases. The sales productivity of our specialty tenants remains strong at $9,557 per sqm while occupancy costs remain highly sustainable at 11.8% of sales. Portfolio occupancy has fallen from 98.1% to 97.3%, a reflection of the challenges stemming from COVID-19, but total like for like MAT sales growth of 3.9% is a strong outcome given the challenging retail environment.
Financial performance and prudent capital management
In FY20, CQR achieved a statutory profit of $44.2m primarily due to the impact of the negative valuation movements. Our operating earnings of $142.7m increased predominately as a result of our asset recycling strategy. Our distribution of 24.52cpu reflects an 80.2% payout ratio on operating earnings of 30.56cpu and takes into account the operational cashflow generated during the period of 28.45cpu.
Prudent capital management remains a core focus of CQR and ensures we can successfully execute our growth strategy and deliver a secure and growing income stream to unitholders. During FY20, CQR successfully raised equity twice. In February, CQR raised $100 million of new equity via a fully underwritten institutional placement to increase our investment in the bp portfolio, growing its exposure to this important tenant and improving the defensiveness and resilience of CQR’s income stream.
In April, CQR raised additional equity of $304.5 million with $275 million via a fully underwritten institutional placement and $29.5 million via a Unit Purchase Plan from retail investors. This equity raise was undertaken to ensure the balance sheet was in a sound position to weather any valuation or earnings impact from COVID-19 and position CQR for growth as the effects of COVID-19 diminish.
As at 30 June 2020, total portfolio gearing was 30.3% at the lower end of the 30%-40% target range. This strong balance sheet and available liquidity of $470 million, means we are well placed to enhance portfolio quality and fund future activity.
Valuations remain resilient
During FY20, we revalued 99% of our portfolio externally by value with 67% revalued in the second half of FY20. Focussing on the movements in the second half of FY20, the shopping centre portfolio valuation declined by $70m or 2.4%. Valuations have taken into account the impact of COVID-19 with valuers including forecast tenant support, reduction of renewal probability, decrease of market rents for existing or pending vacancies and increasing leasing incentives.
Over the second half of FY20, we also revalued the bp portfolio resulting in a $26m valuation increase or 6.2%.
Largely due to portfolio composition changes the portfolio cap rate firmed from 6.18% to 6.03% over the year. Despite a modest softening in cap rates on our shopping centre portfolio from 6.18% to 6.19%, the cap rate of the bp portfolio firmed from 5.5% to 5.0%. These revaluation outcomes for 30 June 2020 reflect the quality, defensive nature and the income growth attributes of our portfolio and reinforce the active asset management strategy undertaken by management.
Strong tenant customer partnerships
Our tenant customers are at the heart of our business. Our engagement, service levels and communication with them are critical to achieving our strategic objectives. Annually, we continue to undertake the industry recognised Net Promoter Score (NPS) survey with Monash University, providing us with key customer insights.
Over the past 12 months, the Charter Hall retail management team has continued to act on the feedback from our FY19 NPS survey and, pleasingly, it is our people and the way we communicate that continue to be our greatest strengths. This results in strong retention of tenant customers and assists with securing new partnerships.
Importantly, we maintain our focus on aligning our capital programs with our major tenant store renewals and this has seen us deliver 10 new or extended major tenant leases delivering an increased portfolio WALE of 7.2 years.
Sustainability and Community
Sustainability remains a critical part of enhancing our portfolio quality and is central to Charter Hall’s approach to property management. Across our platform, we continue to explore opportunities to introduce sustainability initiatives to deliver long-term outcomes that are positive to our unitholders, tenants and the communities in which are assets are located.
During the period, we completed 8.5MW of solar installations at 11 assets. Under our Power Purchase Agreements (PPA) we have increased the solar roll-out program to 27 assets.
Pleasingly, the solar panels associated with the PPA program will deliver approximately 46% of CQR’s energy needs. The PPA Agreements will also provide our centres with a high level of cost certainty in a volatile energy market, thereby benefitting both the community and unitholders.
In addition, we have 8.6MWh batteries currently being constructed for installation at four assets initially, to increase on-site solar utilisation and reduce grid demand costs.
These initiatives form part of Charter Hall’s commitment to net zero carbon emissions by 2030.
Finally, our commitment to our local communities is predicated on our philosophy of mutual success as expressed through the Charter Hall Group’s membership of the Pledge 1% philanthropic movement. This has seen our teams actively partnering with charities and social organisations during the period, giving both time and resources.
To this end, we have continued our partnership with the Two Good Co and their “In Good Hands” community campaign. This year, we distributed 6,800 cookbooks to shoppers across 23 centres increasing awareness of domestic violence. In addition, Charter Hall employees volunteered 2,000 hours as part of the Two Good Co. campaign. We also proudly partnered with Rural Aid on its Drought Relief efforts, raising $196,000 across our centres which help fund 27 semi-trailer loads of large bales of hay and 50 truckloads of water across 20 drought affected farming and rural communities in which we operate.
Our focus on owning and managing property for convenience retailers with a resilient, nationally diversified portfolio, will continue to deliver long-term sustainable growth in earnings for our unitholders. This growth is underpinned by the scale, scope and size of our supermarket activities, our ongoing partnerships with our major convenience retailers and the resilience in our core non-discretionary retail offerings
Going forward, we maintain our commitment to shape the portfolio to deliver resilient and defensive earnings growth for our unitholders.
I would like to extend, on behalf of the board, our thanks to the hard working team that manages our portfolio on a day to day basis. I am proud to see how the team has managed the challenges that COVID-19 has presented and the support that they have shown to our retailers and communities.
Finally, I would like to thank our
unitholders for your continuing
investment in CQR. Our dedicated team,
along with the Board, understand that
we are here to protect and enhance
your investment by delivering longterm
sustainable growth in earnings.
We remain committed to this goal.
Retail CEO, Charter Hall
Executive Director and Fund Manager CQR