CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. My name is David, and I'll be your conference operator today. At this time I'd like to welcome everyone to the Terrafina earnings conference call. [Operator Instructions] .

And I will now turn the call over to Maria Barona of i-advize. Please go ahead.

[Maria Barona, executive]

Good morning. Welcome to Terrafina's First Quarter 2018 Conference Call. I'm Maria Barona with i-advize Corporate Communications. We're pleased to have with us today from Terrafina, Mr. Alberto Chretin, Chief Executive Officer; Mr. Carlos Gomez, Chief Financial Officer; and Mr. Francisco Martinez, Investor Relations Officer. Mr. Chretin will be taking us through the company overview and operating review, and Mr. Gomez will review the financials.

Before we begin, we'd like to refer you to the forward-looking statements as to the note in the quarterly report. Any information expressed or implied during the call may include forward-looking statements which could involve certain risks or uncertainties. Terms such as estimate, project, plan, believe, expect, anticipate, intend and similar expressions may identify these statements. Listeners are cautioned that forward-looking statements made during this call or by the company's management may change based on various important factors not under the control of the company. These comments represent the company's judgment at the time of the call. The company disclaims, however, any intent or obligation to update these forward-looking statements. Thank you for your attention.

And at this point, I will turn the call over to Mr. Alberto Chretin for his remarks. Please begin, sir.

[Alberto Castillo, executive]

Thank you, Maria. Good day, everyone, and thank you for joining us as we review the Terrafina results for the first quarter of the year. We begin the year reporting positive results for the first quarter period. I am pleased to mention that we continue to experience solid leasing activity in the total real estate sector, which strengthens Terrafina's overall operational and financial indicators. As you may remember, during the fourth quarter of 2017, we closed an acquisition that we figured to be operational for only 2 weeks of the quarter. Now, for the first quarter of this year, we had the full benefit of this transaction, which strengthened both the top and bottom lines, contributing to the increase in NOI distributions for the quarter.

Additionally, there was very positive news with regards to some recent M&A activity for a $24.1 million concession for 2 Class A industrial properties. These assets would be financed with the remaining capital obtained from the July 2017 follow-on. These transactions consisted of 330,000 square feet for 2 properties with a 100% occupancy and a 100% dollar-denominated triple-net lease contracts with market lease terms of 7 years.

These 8.5 cap rate acquisitions will enhance the quality of the portfolio in terms of rental rate, age, average remaining lease term, and with the addition of 2 quality international payments. It is important to highlight that Terrafina continues to deliver results that are in line with investor commitments. As such, right now we just completed 95% of the capital deployment from the 2017 follow-on, and midyear review any potential acquisitions that line up with our disciplined approach of long-term value formation and stability for the small remaining portion of the 2017 follow-on proceeds.

Before we begin the first quarter operating highlights, it is important to mention that for 2018, we don't expect to be active in terms of M&A activity beyond usage of the small remaining portion of the capital from the July 2017 follow-on. Our aim, we reiterate, is to fully focus on successfully consolidating and on serving the acquired properties.

In terms of the operating highlights, Terrafina continues on very solid footing. Terrafina completed the first quarter with a total occupancy level of 95.2%, and an average leasing rate of $5.06 per square foot per year. This represents an occupancy rate increase of 26 basis points versus the first quarter of 2017. Including the signed letters of intent, occupancy for the quarter will reach 95.6%. It is also important to mention that same-store operating results for the first quarter also improved compared to fourth quarter results, which was prior to the acquisitions, with 95% occupancy levels and an acquisition rate of $4.98 per square foot per year.

Occupancy rental rate was solid by regions, were in line with market levels. The Northern region reached 96.8% (sic) [ $96.7% ] occupancy at $4.97 per square foot per year. Bajio reached 91.9% occupancy at the rate of $5.17 per square foot per year. And the Central region occupancy reached 93.7% with a leasing rate of $5.29 per square foot per year.

We expect that the leasing rate per foot will remain through our full year 2018 as we continue to appraise the state of finance in the industrial market.

Additionally, same-store occupancy and rental rates by region were also stable. The Northern region reached 96.2% occupancy, a total net increase in per square foot per year. Bajio was 93.3% at $5.05 per square foot per year. In the Central region, we reached 93.7% occupancy at $5.39 per square foot per year.

Leasing activity for the first quarter reached 2.7 million square feet, with the new activity in 20 of our 26 contracts. It is important to mention that over 40% of this year's lease conference separations took place during the first quarter, an indication that for the rest of 2018, our expectations are for various stable and predictable results.

Moreover, combined with their revenue loss, Terrafina signed leases for 2.4 million square feet during the first quarter under discussion. This has been one of the highest numbers of a combined renewal in every renewal in Terrafina's history. New contracts represented a total of 300,000 square feet additional during the period, reflected in positive market outlook, where we start to see a higher number of contracts. Additionally, Terrafina leasing maturity profile improved from 14.5% to 8.1% for the volume portfolio for the rest of the year. We remain very optimistic with regards to leasing activity, as we work also with our property managers to protect and strengthen our market leadership in our tenant relationships.

As a result of total level-off, Terrafina has once again been able to deliver solid cash flows, generating for the distribution of $26.9 million or $13.62 per certificate. Consequently, this resulted in an annualized dividend of 8.9%.

Just to wrap my part of the presentation, I wanted to tell you by saying that we remain very optimistic regarding the evolution of the sector. Manufacturing for export continues to be a pillar of Mexico's economic growth, and we do not foresee that changing. Our understanding from our tenants is that they continue to reach their goals in terms of productivity, quality and cost, and are confident in the ideal location for their operations. Their success is consistent with the market positive outlook for Mexico as one of the main manufacturing product for multinationals. Moreover, the manufacturing sector is fundamental for the operations in the country as well as Mexico's ability to continue attracting direct line business. This is a valued asset that cannot be overruled by whatever political value or party is in power come the elections in July. Therefore, we are confident that the business environment for Terrafina continues to not only be stable, but ready for continued growth. Thank you for your attention. Now we will now turn the call over to our CFO, Carlos Gomez, as he takes us through the financials for the quarter.

[Carlos Espinosa, executive]

Thank you very much, Alberto. I will begin with a brief review of our first quarter financials. Please note that all figures we discuss are in U.S. dollars. However, Mexican peso figures can be provided in the reports for your convenience. Additionally...

[Technical Difficulty]

EBITDA and FFO figures, exclude noncash items as well as nonrecurring and transactional-related expenses, the latter of which are all included as part of the AFFO.

As Alberto mentioned, one of the first quarter highlights was that we were able to see the contribution of the December 2017 acquisition reflected in the financial results. Additionally, the same reduction that took place was also relevant of Terrafina paid USD 47 million at the end of the quarter. This will benefit the AFFO with our financing terms decrease and therefore, on our quarterly distributions.

To begin, let me disclose our same-store first quarter financial highlights compared to last year. Rental revenues increased by 3.6% for a total of USD 34.9 million. NOI reached USD 33.9 million, a 2.4% increase, with an 87.5% NOI margin. At the EBITDA level, USD 30.2 million were generated with a 78.1% EBITDA margin.

Finally, AFFO reached USD 18.3 million, which remained stable compared to the first quarter of 2017.

Moving now to our consolidated numbers. Rental revenue increased by 17.6% to USD 47.4 million compared to the first quarter of 2017. At the NOI level, revenues reached USD 46 million, a 16.2% increase versus the same quarter last year. This resulted in an 87.3% NOI margin. While this is lower than our expected 2018 margin in the low 90s, as we mentioned in prior calls, this is due to the property taxes paid during the first quarter, and later on was reversed by our tenants.

EBITDA for the first quarter reached USD 41.3 million, contributing a USD 5.6 million increase compared to the first quarter of 2017, to reach a 78.4% EBITDA margin for the first quarter. FFO levels reached USD 29.7 million for the quarter, a 19.2% increase. FFO margin reached 56.4%, again, an increase of 106 basis points. AFFO was USD 26.9 million, a 22% increase, while the AFFO margin for the first quarter was 50.7%, a 188 net basis points increase.

This led to total distributions per certificate of USD 0.034 per certificate for a total of USD 26.9 million, which in pesos was MXN 505.2 million or MXN 0.639 per certificate for the period. On the ownership, as of March 31, 2018, Terrafina has a cash position of USD 111 million. And as an additional source of liquidity, Terrafina has over USD 248 million available in its revolving credit facility.

Total debt at the end of the quarter was USD 1 billion, and concluded with a 40.6% LTV, which is a result when compared to December 2017, as we paid down USD 47 million of the revolving credit facility at the end of the quarter.

Additionally, Terrafina registered 5.6x in debt service/coverage ratio. This is in full compliance with our covenants. Thank you for your attention and time.

At this point, I will ask the operator to open the lines for the question-and-answer session.

[Operator]

[Operator Instructions] We will take our first question from Marimar Torreblanca with UBS.

[Marimar Torreblanca, analyst]

I have a couple of questions. The first one is that, given your comments that you're seeing a stable outlook for the first quarter for the remainder of the year, what do you think outside your dividend per share will come to bridge the gap to your pre-follow-on offering levels? Do you think this is only FX, or is there anything else you're expecting from the existing portfolio that could boost your FFO, and therefore, your dividend per share further? And then my second question is, if you could give us some color on potential capital recycling transactions that could improve your portfolio further? And just finally, if you could confirm your lease spreads for the quarter?

[Alberto Castillo, executive]

In terms of your first question, yes. We expect to return to -- the DPS of the first quarter of 2017 during the year. We still have the 5% remaining from the proceeds of the 2017 follow-on. Additionally, we do have some opportunities for our positions to fully deploy the -- [ that additional 5% ]. In addition to that, I want to remind you, Marimar, one of these acquisitions that we made relatively quickly from the follow-on were done with equity. We still have the opportunity to leverage some of these acquisitions in order to make sure that we return to the distributions that are going to allow us to go back to the EPS of first quarter 2017. And so, that is going to happen during the year. Additionally, we still have some opportunity for development, for perhaps some available still opportunities that may come up. Also that we have also some available direct authority to deploy them on the relevant, which also has -- it's a very clear result for doing distribution. So that is an opportunity. And so, the answer is, that yes, of course, that's one of the plans. And I want to also mentioned that, of course, we will return to EPS growth. I just want to mention this acquisition will also enhance substantially the quality of the portfolio in terms of the diversity of the tenant, in terms of industrial sectors, and indeed the size of the quality portfolio, so poise us to capture additional opportunities. Once one wins an opportunity, it passes from the current situation. So that's -- so we expect that the dividends begin to go back to those levels, and totally also we -- it is -- the performance of the stock will also -- will return to also because of the size of the portfolio. On the second question, in terms of capital recycling, yes, an initiative that we also have in relation in terms of we always identity opportunities to perhaps close the properties at any market where we may want to reduce our exposure or properties that aren't our entity, but we -- that is something that we are continually evaluating. At this point, we never did define some, so probably there may be a target for capital recycling, but at this point, we don't hear that we will proceed on anything in the very short period of time.

[Francisco Martinez, executive]

Marimar, sorry, this is Francisco. For your last question regards to leasing spreads, as you know, we have a very productive property management team that are always in the field looking to negotiate in advance with tenants that may expire their contracts. We have seen very stable lease spreads in the 2%, which actually was what happened for the first quarter of 2018.

[Marimar Torreblanca, analyst]

Just to follow-up on the first question a little bit, if I may. So what we should expect is that to get back to the dividend per share metrics that we had last year, you're going to do more acquisitions in the second half, right, which is what you were talking about a couple of months ago, as well?

[Alberto Castillo, executive]

Yes.

[Operator]

We'll take our next question from Pablo Ordóñez with Itaú.

[Pablo Ordóñez, analyst]

My question is regarding your occupancies. It seems that the occupancy in Bajio region continues to be the lowest. Can you comment on the supply and demand dynamics that you're seeing in this region? And whether should we expect this figure to improve in the -- for the year?

[Alberto Castillo, executive]

In terms of occupancies, first off, we have occupancy in the facility apartment, we have one property that was -- that we had an expiration that will renew. And then we were also in the Central market in [ Puebla ] in the one -- we have also one [ building ] that has not been occupied for quite some time, but we see the dynamics in Bajio, the 2 expirations that didn't renew, we do have some tenants that have expressed some interest on occupying both facilities. So this churn on the Bajio continues to be partly and this sort of -- we expect to be leasing through the next few months.

[Operator]

We'll take our next question from Vanessa Quiroga with Crédit Suisse.

[Vanessa Quiroga, analyst]

The question that I have is regarding the acquisition that you announced yesterday. If you can clarify if this was that part that was missing or remaining from the larger portfolio regionally agreed last year? And if not, if you can provide details of the geographical footprint of this portfolio, and who the seller was?

[Alberto Castillo, executive]

Vanessa, these acquisitions were part of the transaction that we announced before. We bought these 2 properties from the same seller that we bought the portfolios that we announced prior to last year. These 2 properties are in the [ Coahuila ] area. These 2 properties are occupied by 2 very good global companies that are contributing to the quality of the portfolio. So to answer your question, yes, these 2 properties we bought from [ Davisa ]. [ Davisa ] is at the center of the private portfolio. If you remember, we retain also property managers and now mostly only in the [ automotive ] center.

[Vanessa Quiroga, analyst]

That's great. The other question that I have is a follow up on the rents. When you say that lease spreads are stable, does that mean that the rents that you're getting on new contracts are more -- are very similar to the ones in place? Or are you saying that currently your rents are pretty much in line with market levels?

[Unknown Executive]

Vanessa, this is [ Arturo ] . What we referred to when we were talking on the mix spreads that are stable, it's basically that we see pretty much in line with U.S. CPI. Lease contracts usually have a step up every year, and we have seen it in the range of 2%. There are some specific markets where we have the opportunity to not break because we are below market levels, but if this has been only a few occasions where we have the opportunity. So the other role picture for Terrafina in terms of lease spreads is that it should behave in line with U.S. CPI in the 2% range.

[Vanessa Quiroga, analyst]

Okay, okay. That's great. And finally, I want to ask you, regarding the regions where you're present, is there any one that concerns you in terms of supply or the competitive dynamics that you are seeing currently?

[Alberto Castillo, executive]

No. In terms of regions, we are very pleased with the geographical distribution of our portfolio. Do remember, we have -- the property managers that we have are in different parts of Mexico. And they have had the proven record that says not only in terms of renewals, but also capturing new opportunities. So in terms of regions, we are very pleased with the distribution that we have with the North and the Bajio and the Central, and that we don't have any initiatives to change that distribution of our portfolio.

[Operator]

We'll take our next question from Jorel Guilloty with Morgan Stanley.

[Wilfredo Guilloty, analyst]

I have two questions. So the first one is, you've gotten to a point where you've deployed 95% of your capital raise last year into new assets. So with that in mind, I was wondering if you can comment on the M&A environment in terms of what sort of assets you see available. Do you see more people willing to sell right now? Is the bid/ask spread narrowing? What sort of cap rates are you looking at? How would you intend to fund going forward? So just general comments on how you're seeing M&A. And then the second question is on leasing. So you had a strong quarter in terms of leasing, leasing retention was very high, but I wanted to get more of a sense of new leases. So if you provide some color on demand for new leases, have you seen an increase, a decrease, is it flat versus what you were expecting? What are the biggest concerns for newer tenants?

[Alberto Castillo, executive]

Certainly. Yes, in terms of the M&A environment, we do see that and we do hear a pipeline of potential acquisitions. We do see that, the sellers are motivated because they see now that the [ figures ] and the auctions are an option or an alternative for them to close the value creation circle. And we have a competitive advantage when it comes to acquisition because of the strategies that we have in terms of having the property seller or property managers. So we do see opportunities that are there for us to continue with the growth with M&A. And we do see the potential sellers that are motivated. At this time, because of the situation and because of where we are, we are the ones that are holding on to be proactive in proceeding more M&A activity. And I think that this is due to the macro that we have now, but we continue -- we have a proven record with that because of our latest acquisitions, and we still see an opportunity with very good quality properties that will be available for acquisitions. And then the cap rate for acquisition will be as we mentioned before, in the 8.5% to 9% that are the [ reasons ] for what we have been deploying capital. In terms of leasing activity, we -- our current tenants are being very successful with the operations and they are very pleased with the performance of the facilities. So therefore, that's why we have very high percentage of renewals and we continue to see opportunities for expansions in the -- for the new leases as well, we do have the opportunity to capture those mostly because of our property managers. We see some comments from some of our property managers that are also developers, that are -- they are limiting the starts in terms of new facilities within their own development plans. And so, we see that during 2018, perhaps it's going to be a less activity in terms of starts of new developments, because of perhaps to try to balance the demand with the supply of the space. And that we see as a positive path in order to not have a lower supply of office space, that may put some pressure on rents.

[Operator]

[Operator Instructions] We'll take our next question from Gordon Lee with BTG.

[Gordon Lee, analyst]

A couple of quick questions. The first is, there was some talk in the market that some of the properties that you had acquired with the portfolio that you purchased after the follow-on of last year had some share of rents that were above market. And I was wondering how you felt about that, now that you've absorbed the properties and have become more familiar with them? And then the second question is just, given that it seems more and more likely, that NAFTA 2.0 will happen, are you seeing a change in the pace or the urgency of approaches from clients for additional space or for a new space?

[Alberto Castillo, executive]

Yes. Well in terms of our rent above market, I think that first, precisely because of the quality of the facilities, the age of the facilities and the fact that our manufacturing for export. And the fact that now the operations in the automotive business now are more vertically integrated. And the fact that tenants now to be more syncretized with the OEMs. They demand to have facilities that are more specialized, and they demand higher quality, they demand a lower current pace of the building. They are beyond the markets, certainly much more perhaps in a sophisticated and logistical distribution. And that's why the rents are above market. But that is -- a positive aspect of that is that, of course, it's because of the increasing in NOI, but also because of the fact that the tenants also invest substantial amounts of money on the facility to accommodate the vision they're building. So that's why,we see the above-market rents on manufacturing for export as positive because of the increased NOI that those facilities are going to produce. And in addition, how safe the contract is going to be because of the investments from the tenants. We also have a current record of success on renewing these types of facilities at the same or better rent at the expirations. In other words, the additional investment that sometimes has been done, in particular on this portfolio that you just mentioned, was not -- there was not amortizing but also was part of the rent. It will be part also of the renewal -- the renewal factors of the financial delivery, the renewal package of that contract. In the second question, in terms of the change of NAFTA, yes, we were able also to renew and due to have some expansions of the lease contracts on our tenants, even at the high level of uncertainty of NAFTA. But now that we have more sanity, we continue to -- as we mentioned during the call, we have very good rate of renewals. And the tenants, we're positive talking to our tenants, and our tenants continue to be very, very positive about their operations. When we talk to them, we talk to them about what kind of products they're using for using export of their facilities. Some of them use NAFTA; some of them use the index, which is into our program. In the event there was going to be a cancelation or a reduction on the NAFTA, they had some contingency planned. But now the general consensus from the impacted tenants is that, they're going to continue with the operations the way they were doing before.

[Operator]

We'll take our next question from Pablo Ordóñez with Itaú.

[Pablo Ordóñez, analyst]

Just one brief follow-up regarding your balance sheet. Now that you plan to focus on adjusting the acquisitions, is there any room to reduce leverage this year? And what should we expect in terms of loan to value for the year?

[Carlos Espinosa, executive]

Yes, Pablo. Yes, as we have discussed, the optimal level for LTV for Terrafina is between 38% to 42%. Given the pains that we took to take over facility, we are improving 0.6%, which is [ all we're talking about ] for Terrafina. So I am not sure -- I don't think that we're going to make any additional payments to that. And I think that the metric for the LTV is going to be very stable between 40.2% and maybe 41%, but I really don't see significant change in the next month.

[Operator]

[Operator Instructions] We'll take our next question from Eduardo Altamirano with HSBC.

[Eduardo Altamirano, analyst]

Just wanted to understand, in terms of what you're seeing within the marketplace and in terms of cap rates region-by-region, where the opportunities are. Whether those cap rates are aligned with where your cap rate is as well as if they are, let's say, above yours, is that because of the lack of portfolio maturity, or where kind of these portfolios within the context of the M&A process? Just wanted to get some color there.

[Alberto Castillo, executive]

Yes. The cap rates, you know that we target for our position between 8.5% and 9%. We think that there was during the last, probably 2 years of the compression, the cap rates rising, that we'll be reaching a point where they're going to be -- there is going to be some stability. I think we'll be reaching a balance between the expectations of the sellers and the opportunities for good quality assets. So we don't foresee any changes in terms of the cap rates at this point.

[Eduardo Altamirano, analyst]

And in terms of those expectations between, let's say, the cap rates the sellers are expecting now, is that because the function of just not market activity? Is it just leverage ratios as well that they're expecting you to incur? Just if you could throw out a little more color there?

[Alberto Castillo, executive]

Sure. I think the cap rates -- the motivation of the sellers to sell the portfolio, I think has several, [ several aspects ]. One is, to monetize their portfolios, but also to be [ continuous to their plans ]. It might be that we will reach a balance between the expectations of the sellers, and I give from my perspective of where we're saying in terms of value. Every time that we're going to assess an acquisition, we want to go back to fundamentals of the real estate, also the quality of the tenants and also the quality of the lease contracts. So we don't see any changes in terms of cap rates in the near future, as a sentiment that there is a balance between the expectations of the sellers and where we're staying in terms of approach to acquisitions.

[Operator]

We'll take our next question from Francisco Suarez with Scotiabank.

[Francisco Suarez, analyst]

The question that I have relates to what to do going forward on how to fund acquisitions. I mean, you're not trading at such a big discount to IFRS NAVs compared to other companies. Clearly the market has good understanding of what your strategy is, and how that has been like in the market. The thing here is that, to what extent, now that considering your loan-to-value is relatively high, you might actually be willing to issue equity at discount to that NAV? And I'm sorry to insist on this, and why not considering creating a reserve out of AFFO now that you have been able to execute it very well your acquisitions, and improve your overall margins in AFFO to potentially help fund acquisitions going forward?

[Alberto Castillo, executive]

Francisco, well, thank you for the question. Definitely, I want to clarify that whatever acquisitions we do in 2018 are going to be with the balance of the proceeds from the follow-on last year. We may elect to leverage slightly some of those decisions, but we not expect to do any follow-ons. We do not expect to raise more quality to -- for future acquisitions this year. And that the -- in terms of the acquisitions that we -- as I mentioned, that we introduced this year is going to be executed with the proceeds from the follow-on of last year.

[Francisco Suarez, analyst]

And on the second question on the related to potentially use and create a reserve out of AFFO to help you fund further acquisitions or perhaps engage in more asset recycling?

[Alberto Castillo, executive]

Yes. No. I think we don't have any plans to make any provisions from [ AFFO, from capital position ] or renewal expenses. We will continue with a quality of distributing our security deposits 100% of the AFFO.

[Operator]

And there are no further questions on the line at this time. I'll turn the call back to Mr. Alberto Chretin for his closing remarks.

[Alberto Castillo, executive]

Well, thank you, again, for your interest and attention here today. Please do not hesitate to contact us with any questions you may have. Have a great day.

[Operator]

This does conclude today's program. Thank you for your participation, and you may now disconnect at any time.