CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Transcript 2019-Q1

[Operator]

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Terrafina earnings conference call. [Operator Instructions] Thank you for your attention.

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

[Maria Barona]

Hello, and welcome to Terrafina's First Quarter 2019 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 the company through the 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 per 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 certainties. Terms such as estimate, project, plan, believe, expect, anticipate, intend and similar expressions may identify such statements. Listeners are cautioned that forward-looking statements made during the 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 this call. The company disclaims, however, any intent or obligation to update these forward-looking statements.

Thank you for your attention. At this point, I will turn the call over to Mr. Alberto Chretin for his opening remarks.

[Alberto Castillo, executive]

Thank you, Maria. Good day, everyone, and thank you for joining us today as we review results for the first quarter of the year. Terrafina started off the year with positive results. First off, leasing activity continues to be solid with a high level of renewals supported by productive manufacturing for export activity. New developments also remain on track as we made progress on another expansion that will be announced soon. Our expectation is that there will continues to be a positive trend of additional expansions and built-to-suits for the remainder of 2019.

Moreover, we will continue analyzing specific built-to-suit projects and expansions that will bring additional benefits to Terrafina with attracting double-digit development yields in the range of 10% to 12% as we continue to see a growing demand for new space from existing tenants.

In terms of operating highlights, Terrafina continues delivering positive results in this area as well. Total occupancy reached 95.9% and the average leasing rate was $5.18 per square foot per year. These represented an occupancy rate increase of 72 basis points versus the figures reported during the first quarter of 2018 and also an increase of 59 basis points compared to the fourth quarter of 2018.

Including the signed LOI's, occupancy for the quarter reached 96.5%.

Occupancy and rental rates result by region we're in line with market levels. The northern region reached 97.6% occupancy at $5.10 per square foot per year. Bajio reached 91.8% occupancy at the rate of $5.24 per square foot per year. And in the central region, occupancy reached 94.8% with the leasing rate of $5.39 per square foot per year.

As the stable dynamics in the industrial market prevail, we expect that the stability of the portfolio will remain on track throughout full year 2019.

Leasing activity for the first quarter reached 2.3 million square feet with renewal activity in 21 out of 27 expirations. Moreover, combined with early renewals, which is a key indicator of the importance for our tenants to secure the permanence of their operations, Terrafina signed leases for approximately 1.9 million square feet in the first quarter of 2019. Finally, new contracts represent a total of 400,000 additional square feet during the period.

All of these positive results translated into solid and consistent cash flow with a generation of $24.2 million in cash distributions or USD 0.0306 sales per certificate.

Before I turn the call over to Carlos, I wish to mention that with regards to the share buyback program, our aim is to continue actively identifying opportunities for increasing our position as the current price is at a discount relative to NAV.

That's all for me. Thank you. Carlos, please go ahead with the main financial metrics for the quarter.

[Carlos Espinosa, executive]

Thank you very much, Alberto. And thank you to all of the participants in the call for joining us today. I will begin with a brief review of our financials for the first quarter of 2019. Please note that all figures discussed are in U.S. dollars. However, Mexican peso figures are also following the report for your convenience.

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

To begin, let me discuss the first quarter of 2019 financial highlights compared to last year.

Terrafina's rental revenue decreased by 1.2% to reach USD 46.8 million as a result of a larger amount of grace period, for USD 1.2 million, granted to some of our top tenants as part of our renewal negotiations closed in the fourth quarter of 2018. It is important to mention that we expect to see the rental revenue to flow normalize in the following quarters.

The NOI level for the first quarter of 2019 reached USD 45.8 million with an 87.3% NOI margin. The lower NOI margin was caught by the seasonality of our business where property taxes are paid during the first quarter of the year. EBITDA was USD 40.9 million with an EBITDA margin of 78% as a result of the above-mentioned effects in rental revenue and higher property taxes.

With regards to FFO level, USD 28.4 million were generated in the first quarter of 2019 with an FFO margin of 54.6%. Finally, AFFO levels reached USD 24.2 million with an AFFO margin of 46.1%.

As we mentioned during the fourth quarter of 2018 conference call, we expected a higher amount of tenant improvements and leasing fee as a result of the large leasing activity seen in the last part of 2018. Moreover, we expect annual maintenance Capex in the range of $0.20 to $0.25 for the total GLA, which translates to USD 8 million to USD 10 million for full year.

On the balance sheet as of March 31, 2019, Terrafina has a cash position of USD 69.3 million. Also, Terrafina had USD 250 million in its revolving credit facility, which could be utilized while still remaining within the loan-to-value limits.

With reference to total debt, Terrafina has USD 1 billion in debt by the end of the quarter and a 41.1% LTV and a 3.6x debt-service-coverage ratio, which is in full compliance with the bond covenants.

At this point -- thank you very much for your attention. At this point, I will ask the operator to open the line for the question-and-answer session.

[Operator]

[Operator Instructions] And our first question from Vanessa Quiroga with Crédit Suisse.

Our next question comes from Marimar Torreblanca from UBS.

[Marimar Torreblanca, analyst]

I have a couple of questions. The first one on your rental revenues. The decrease you mentioned that has to do with longer grace periods that you give to some tenants in the renewals. Can you give us a bit more color on why you have to give these longer grace periods since market fundamentals in the different regions overall seem pretty good?

And then the second question related to your buybacks. Can you also provide some more detail or define what you mean by finding opportunities for buybacks? What -- would you like to see to be a bit more active on your buyback programs?

[Alberto Castillo, executive]

Yes. Thank you very much. Well first -- on your first question, yes, we had -- during the last part of the fourth quarter of 2018 and in this quarter, we have basically 2 or 3 very large negotiations with our largest tenants. These -- the result of these negotiations was that we were able to secure lease contracts for very large amount of square footage in that -- and for terms that go beyond 10 years with 2 -- with our 2 largest tenants.

Part of the negotiation was that we had to give these free rents, or this allowance, which has 2 characteristics: one was we were able to secure these contracts, as I mentioned, beyond 10 years; secondly, was that we had also -- we were able to increase the rent. And one particular attribute of this rental session was that the tenant is going to invest those rents in the building.

So we were able to, as I mentioned, to achieve these long contracts. And we, in the proceeds, are going to be invested into those buildings, but we get the negative, of course, result on the rental revenue of $1.1 million for the quarter, which is part of the difference on the results on the rental revenue.

As you can see, we had $1.1 million deduction due to the rental revenue result that I just explained. And the other one was because, during first quarter, we paid $1.1 million also on the property taxes that we -- this is a one-timer. And I want to emphasize that these -- both of these events are a one-timer.

As you remember, when we had to give these rental concessions, which is very unfortunate. But unfortunately, this is a practice that is becoming more common in the market. This practice was initially based on the industrial resale developer. They gave that to new tenants, however, unfortunately, this has been spread throughout the business. And when you have a tenant or a couple of tenants who got the leverage because of the size of the operation and because of the possibility of leasing that facility for a longer period of time. And then the fact that the proceeds from the -- those concessions are going to go into the building. We saw that as a positive but with a negative temporary result for the quarter.

In terms of the second question, yes, we -- as you remember, we did -- we put in motion our buyback program, and we were very successful. We bought certificates at MXN 24 per certificate at that time, and we continue to do that. We stopped that for a period of time when it was -- we were not permitted by the regulator because of the timing to interrupt the buyback program.

And then at the time that we were thinking about renewing the buyback program, the price of the certificate was at substantially better price. And we felt that at that time, it was better for the time being to stop the buyback program. However, what I mentioned also is that we are -- hopefully, we'll continue to be there. And if the conditions warrant it, we will go back to put in motions the buyback program immediately because we're very prepared for that. I hope I answered your questions.

[Operator]

And our next question comes from Eugenio Saldaña from GBM.

[Luis Saldana Flores, analyst]

I have two. First one, we observed in the cash flow disposition of property this quarter also we observed in the fourth quarter of 2018. I mean I'm curious on what those properties are? And if you provide more details on how that transaction was held? That is the first one.

The second one is, I mean, I want to consider, I mean, all the picture. You say that you renewed good contracts with grace periods. So I believe that, that led through higher leasing commissions this quarter. However, the weighted average remaining length of the contracts decreased this quarter. So I just want to have a sense on what's going on here.

[Alberto Castillo, executive]

Well, in terms of the first question, yes, there was a -- we sold a tract of land like -- which is a -- it was a property that we feel that it not in line with the assets of Terrafina. We had held that tract land for quite some period of time. There has been some demand to build something but to rent in pesos and with the profile company that perhaps don't suit our expectations in terms of the profile of our tenant. And there was an opportunity to sell that land, and we did that. That's the number one.

And then the second question...

[Carlos Espinosa, executive]

On regards of the grace periods, what it looked in the bottom line on average because he's looking that the average lease period of the contract didn't increase.

[Luis Saldana Flores, analyst]

Yes. I mean -- so sorry...

[Alberto Castillo, executive]

Can you repeat the question please?

[Luis Saldana Flores, analyst]

Yes, I mean...

[Alberto Castillo, executive]

The second question, please...

[Luis Saldana Flores, analyst]

Can you hear me?

[Alberto Castillo, executive]

Yes, yes. Can you repeat your second question, please?

[Luis Saldana Flores, analyst]

Sure. Yes. I mean, this quarter was a bit, I mean, higher leasing commissions. And I mean you mentioned that, I mean, top line was affected by these grace periods that you provided to, I think, your renewals or new tenants. However, I mean, when we go and see the remaining length of your leasing agreements, it decreased, I mean, quarter-to-quarter and year-over-year as well. So I mean I just want to reconcile, I mean, how is this, I mean, living together, all these variables? And how did it happen?

[Alberto Castillo, executive]

You mean the remaining lease -- the lease expirations. Okay. When we increased on these contracts we'll increase the length of the rent contracts. And then you're talking about the remaining -- I'm trying to look at the department that you're referring to.

Okay. I see the difference there. I'll tell you what -- that I don't have the answer to that right now. And I think because, in these contracts, we did increase the rent of the lease contracts. Let me get back to you on that.

[Operator]

And our next question comes from Victor Tapia with Bradesco.

[Victor Tapia, analyst]

My first question is still regarding the grace periods, we understood what happened in this quarter. But looking forward, what is the company's expectations regarding these grace periods? Do you think should a high occupation gives you guys a higher bargain power and negotiating these grace periods? So this is my first question.

And the second one, when we look at the development CapEx, we saw some speeding up that development CapEx this quarter. So can you give us a little bit more color on how is the demand for new hires, compliance also for new clients? Okay.

[Alberto Castillo, executive]

Okay. I think the interest of the grace period of the free rent. What we are doing, and this is something that the way we're going to treat these free rent is we're going to agree with the tenants that we're going to spread that grace period over the length of the contract in order to have -- not to have the substantial impact at the beginning of the negotiation. In this case as I mentioned before because of the large size of the contracts and because of the fact that the proceeds were going to go back into the buildings, we agreed to give the free rent up front. But in the future, it's going to be treated, like I mentioned, we're going to spread these throughout the lease -- the rest of the lease contracts.

And in terms of development, if I understood correctly, we do plan to use about $30 million during 2019 on development. And many of these developments are going to be on our own land. However, this is possibility that we have some of these developments on the land owned by some of our property managers through our joint ventures.

[Operator]

And our next question comes from Francisco Chavez with BBVA.

[Francisco Chávez Martínez, analyst]

Yes. I have a question regarding the cash distribution policy, will you continue distributing the 100% of the AFFO this year?

[Alberto Castillo, executive]

Yes. Our policy, for now, is that we're going to continue with a policy of issuing 100% of the AFFO.

[Francisco Chávez Martínez, analyst]

Okay. And the second question will be if I understand correctly, these nonrecurring factors on the leasing commissions and in the tenant improvement during our last quarter will not be present in the coming quarters, right? So if we -- can we expect a recovery on the AFFO per certificate?

[Alberto Castillo, executive]

Well, the idea is that we have operated fully for the remainder of the year, top of the year, so it's between $0.20 and $0.25 per square foot per year for the entire portfolio.

[Francisco Chávez Martínez, analyst]

Okay. So -- in once you -- we saw a higher percentage of CapEx affecting the AFFO. So we can expect that to normalize in coming months, right?

[Alberto Castillo, executive]

That is correct.

[Operator]

[Operator Instructions] Our next question comes from Jorel Guilloty with Morgan Stanley.

[Wilfredo Guilloty, analyst]

I have a question regarding your leasing rents. So we've seen that there's a difference of nearly 8% between the average leasing rent per square foot that you published just $5.18 versus an effective rent of $4.75. The way we get to an effective rent is based on the rental income that you published divided by the occupied GLA.

Given this, I have a few questions. First, does the average leasing rent that you published, does that take it into account in the grace period?

And the second question is when should we expect effective rent to reach leasing rent?

[Alberto Castillo, executive]

That's a very good question. Well, the answer to the first question is yes. The second one is yes. We -- our expectation is that we're going to close the gap between the effective rent and the published rent as the published rent has to do with the rent of the contracts. And feel that these also speaks to the long-term stability of the portfolio by being able to agree and to sign those higher rents on the lease contracts. And as this portfolio stabilizes, we expect the gap between the effective rent that you're correct. The $4.75 per square foot per year on the effective rate as to stabilize and to be closer to the reported average rent.

[Giovanni Bisogno Guinea, analyst]

But is this transition period like 3 months, 6 months, is there a timeframe that we should be thinking about?

[Alberto Castillo, executive]

No. I think that this -- we expect to have this to happen throughout the year.

[Giovanni Bisogno Guinea, analyst]

Okay. So by year-end, it should be one on top of the other?

[Alberto Castillo, executive]

Well, I think it should be closer. We expect that gap to be closer, yes. Because remember that we have a high-leasing activity, so it may be that we -- it takes a little bit more time to reach that point.

But the effective rent at this point, as you point out correctly, is lower than the reported rent because, what I mentioned, the rent that we are reporting is the average rent of these contracts.

[Operator]

We will take our next question from Vanessa Quiroga from Crédit Suisse.

[Vanessa Quiroga, analyst]

Apologies for not being able to respond earlier. So my question is regarding your growth trends. Right now, the balance sheet seems more or less at its potential, at its optimal level, I would say. And you are distributing 100% of AFFO. So I'm wondering what are your plans in terms of being able to grow GLA or a net asset value going forward?

[Alberto Castillo, executive]

Thank you, Vanessa. Yes, you're correct. I think that our growth plans are exclusively for this year on development. We are focusing on development of expansions of our current tenants and participate in a couple of build-to-suit opportunities that we see in the near future. And based on that, we have within our plans to use for this year about $30 million, which amounts to close to about 1 million square feet in developments of both expansions and built-to-suit opportunities exclusively.

[Operator]

[Operator Instructions] And it looks like we have a follow-up question from Vanessa Quiroga with Crédit Suisse.

[Vanessa Quiroga, analyst]

Yes. Just going on with the same topic and regarding a potential follow-on, if you would plan for that at some point in the future given that current share is more or less at the levels when you last did such a placement? So wondering what are your thoughts on that?

[Alberto Castillo, executive]

Yes. No, Vanessa, we don't have any plans to -- for -- to raise more capital. Certainly, we will not do that unless we are trading at a premium. And at this point, it's not in the horizon for us to consider a follow-on.

[Vanessa Quiroga, analyst]

Sorry, can you repeat, Alberto, unless there is what condition? Sorry.

[Alberto Castillo, executive]

That we trade at a premium.

[Vanessa Quiroga, analyst]

Okay. To your net asset value.

[Alberto Castillo, executive]

That's right. Premium to -- I'm sorry, yes, at premium to net asset value. Correct. Thank you, Vanessa.

[Operator]

And our next question comes from Armando Rodriguez with Signum Research.

[Armando Rodriguez, analyst]

Well, my question is about your outstanding debt, particularly the notes that have a short-term maturity, for example, and our next senior notes, tenured-life loan. What we should expect here? You are you expecting maybe some financing in those loans, maybe in the short term.

[Carlos Espinosa, executive]

Yes. Armando, on regards of our debt, the next maturity that we have is a small one, which is due on next year. For the important part of the maturity of our debt is for the fourth quarter of 2022. So we are looking at the market to see which alternatives we may have. But since we have plenty of time to find the best solution or the best alternative for our debt, we will be keeping -- looking at the market and we'll access it whenever is the right moment. So but we are really not in a hurry since we have plenty of time to look at the different alternatives.

[Operator]

And our next question looks like a follow-up from Eugenio Saldaña with GBM.

[Luis Saldana Flores, analyst]

Yes, just a follow. I mean I just want -- if you could remind me how, I mean, top line is accounted for? I mean my understanding is that, for example, if you have certain agreements with growth, I mean, you have to average that rent throughout the life of the contract. I mean Is that correct?

[Carlos Espinosa, executive]

I'm sorry, can you repeat the question?

[Luis Saldana Flores, analyst]

Sure. My question is that my understanding is that in top line, if you have a long-term lease and you have certain price that is growing perhaps with CPI, you are expected to average that rent, I mean, for the full life of the contract. So you won't see any of the increases for accounting purposes. Is that correct?

[Carlos Espinosa, executive]

No, no, no. What we do is we recognize the lease that has to be charged every month. Based on the contract of each client, whenever they increase most of the time by CPI of the rent is recognized on that particular month. We recognize that increase. But it's not an average rent because of -- since we have some long-term lease agreements we would have to recognize a tariff, that wouldn't make sense. So we prefer to recognize every month the right tariff for each client. Because also that's the way we invoice them. So that's the best way to do it.

[Operator]

And it does appear that there are no further questions over the phone at this time. I would like to turn it back to the speakers for any closing remarks.

[Alberto Castillo, executive]

Well, thank you all for your attention here today. We look forward to speaking with all of you again and keeping you updated of the latest developments at Terrafina. Have a great day.

[Operator]

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