CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Transcript 2020-Q2

[Operator]

Greetings. Good morning. My name is Jen, and I will be your conference operator today. At this time, I would like to welcome everyone to Terrafina's Second Quarter Earnings Conference Call. [Operator Instructions]

I will now turn the call over to Francisco Martinez, Terrafina's Investor Relations Officer. Please go ahead, sir.

[Francisco Martinez, executive]

Thank you, Jen, and good morning, everyone. Welcome to our second quarter 2020 Conference Call. We're pleased to have with us today from Terrafina, Mr. Alberto Chretin, Chief Executive Officer; Mr. Carlos Gomez, Chief Financial Officer. Mr. Chretin will take us through the company's overview and operations, and Mr. Gomez will discuss the financials.

So before we begin, I would like to refer that the forward-looking statements, as per the note in the quarterly report, that 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 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 out of the company's control. These comments represent the company's judgment at the time of this call, so the company has no intent or obligation to update these forward-looking statements.

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

[Alberto Castillo, executive]

Thank you, Paco. Good morning, everyone. I'm glad to share with you the main highlights of our second quarter earning results.

The COVID-19 outbreak has had a negative economic impact in most sectors. However, the industrial real estate space has been resilient and with this our portfolio. We have had minor impacts in cash generation as we continue to see sound leasing activity supported by high renewal rate.

As we shared in our first quarter conference call, collections have behaved well. We saw an 89% level in April, an 83% level in May and an 85% level in June. This translated into an average level of 86% for the quarter, which meant a modest impact in our cash balance. We expect to see a decrease of approximately 3% in our annualized rental revenue for 2020.

To provide more detail on this, out of the 16 contracts that mature in the second quarter, 15 were renewed for a total of 1.6 million square feet. Additionally, we signed new contracts for a total of 150,000 square feet. We continue to see signals that Mexico is on track to maintain its position as a key manufacturing partner to the United States, benefiting from nearshoring trends which had increased as a result from both the pandemic and the trade tensions with China. Additionally, as we all have seen in recent weeks, the economic activity in some sectors has been gradually restarting.

This is the case for the manufacturing sector, where most of our tenants have resumed operations and will be ramping up their production levels gradually. We believe this will be beneficial for the overall export sector in Mexico.

As for our ongoing tenant support programs, we have not seen major changes in the number of rent relief requests. Only 13% of our 307 tenants have requested rent deferrals, and we expect that approximately 70% of this will be recovered in 2020 and the other 30% during the first quarter of 2021. Additionally, it is worth noting that we have not granted any free rent concessions to any tenant. This, again, reflects the quality of our tenant base, which is much more exposed to the United States' economic activity. On that note, we have seen a gradual recovery in the U.S. with the reopening of the economy. We believe the relative improvement in the financial markets and the lower jobless claims has helped to improve consumer's confidence. Nevertheless, we also think it is too soon to expect to see spending at the pre-pandemic levels.

At Terrafina, we remain cautious and have kept an ongoing communication with our property managers to monitor our tenant's production activity. It is fair to say our rent collections and deferral requests seems steady. However, we will need to gather more information in the following months to have more visibility on what to expect in the remainder of the year.

As for our liquidity position, we closed the second quarter with $157 million in our cash balance as we paid off $45 million of the revolving credit facility. This improves our leverage level while still leaving us with enough liquidity for any future contingency. We feel comfortable doing this since we see very steady trends in our operations. However, we are still mindful of the overall macroeconomic environment and we'll be vigilant for any change in trends.

As for our development CapEx, we remain focused on expansions and build-to-suits with a 25% -- $25 million budget for the year, which was reduced by half last quarter.

Finally, before we discuss our second quarter's operating highlights, I would like to reaffirm our 85% distribution payout ratio policy as well as our 2020 guidance for distributions in the range of USD 11.50 to USD 11.70 per certificate, and for CapEx in the range of USD 0.26 to USD 0.29 per square foot. As we have said in the past, we will be using the 15% reserve to finance part of the developing CapEx for the year. We believe this strategy is conservative enough for now, given the resilience of our business has proven to be.

Moving on to our operating highlights. In the second quarter, Terrafina leased a total of 1.9 million square feet, with 1.75 million square feet of renewals, which includes 150,000 square feet of early renewals and 152,000 square feet of new contracts. This activity was supported by an 89% renewal rate.

Our lease expirations for the remainder of the year represent 13% of our total G&A or 5.3 million square feet, considering the renewals we did in the second quarter. We expect to see solid trends in leasing activity during the second half of the year. As for our occupancy level in average rental rate, both remained stable at 95.7% and $5.17 per square foot per year. These positive results enabled us to distribute a total of $19.8 million in dividends to our stakeholders or USD 0.0251 per certificate, which implies a 9.2 dividend yield. As stated before, this distribution comes from an 85% AFFO payout ratio.

Before Carlos goes to the key financial metrics for the second quarter, let me just mention that it will be our main priority in the coming quarters to keep our positive trends in leasing activity as our tenants renew their contracts. We will also be actively generating new leasing contracts to preserve our liquidity going forward, all of these while still looking out for the health and safety of our stakeholders, which has been one of our key priorities throughout the crisis.

Thank you, and Carlos, please go ahead with the financial highlights for the quarter.

[Carlos Espinosa, executive]

Thank you, Alberto, and thanks to all the participants for joining us today conference call. Please note that all figures discussed in this call are in U.S. dollars. But Mexican peso figures can be found in the earnings report. Additionally, NOI EBITDA and FFO figures exclude noncash items, as well as nonrecurring and transaction-related expenses, the latter of which are all included in the AFFO.

During the second quarter, net collections reached USD 46.5 million, a 5.9% decrease compared to the second quarter of 2019. As we mentioned in the first quarter conference call, Terrafina's main metrics are now calculated under a collection basis to align our results with a cash generation for each quarter. Therefore, our net collections metric is calculated based on rental revenues minus on collected revenues for the quarter plus collected revenue from the previous quarter. In this way, our distributions are more aligned to real cash generations from its operations.

As for our rental revenue, it reached USD 50.3 million, which implies a 6.4% year-on-year increase. In the second quarter, NOI was USD 44.8 million, a 9.2% year-on-year decrease, which implies a 94.2% NOI margin.

EBITDA totaled USD 39.9 million on a 10% decrease and an 83.9% margin. Finally, AFFO reached a total of USD 23.3 million, a 14.3% year-on-year decrease. Considering an 85% payout ratio, our distribution this quarter was USD 19.8 million or USD 0.0251 per certificate.

Moving on to our balance sheet, we closed the quarter with USD 157.1 million in cash. Also, as Alberto mentioned, we paid off USD 45 million to our revolving credit facility and our leverage level reached 43.2% as of June 30, 2020. The remaining USD 100 million withdrawn from the revolving credit facility will be kept in our cash balance and will be used only for contingency purposes if needed. Also, our debt service coverage ratio stands at a sound level of 3.4x.

Finally, our average cost of debt was 4.45% and our average weighted maturity of debt was 6.5 years.

Thank you for your time and attention. I will now ask the operator to open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Carlos Peyrelongue with Bank of America.

[Carlos Peyrelongue, analyst]

Just a clarification, can you repeat the percentage of ask request for rent referrals? I missed that. As well as confirming the CapEx that you have for the year, I believe you said $25 million. I just wanted to confirm that, please.

[Alberto Castillo, executive]

Certainly, thank you very much, Carlos, for your question. Yes, the percentage of rent relief tenants was at 13%, 1 3 percent. And as I mentioned before, we only gave rent deferrals to those requests of 13% of our -- of more than 300 tenants, and we expect to recover 70% of that during the second quarter of 2020 and the other 30% on the first quarter of 2021.

And in terms of the -- what was the second question, Carlos?

[Carlos Peyrelongue, analyst]

With regards to CapEx for the year.

[Alberto Castillo, executive]

The CapEx is between USD 0.26 and USD 0.29 per square foot per year.

[Carlos Peyrelongue, analyst]

Okay. And in terms of the expansion CapEx, is there anything that was mostly maintenance?

[Alberto Castillo, executive]

Yes. The expansion CapEx, we have -- we reduced by half -- initially, we had -- last year, we have a forecast that we're going to spend about $50 million in build-to-suit and expansions. And we reduced that by half due to the pandemic. And we still are on track to spend about $25 million on CapEx for 2020.

[Carlos Peyrelongue, analyst]

Understood. Okay. Perfect. And so of the -- all the clients that had 13% of your total client base, 1 3, 13% is -- got the rent deferrals, correct?

[Alberto Castillo, executive]

That is correct.

[Carlos Peyrelongue, analyst]

Perfect. Okay. And you will -- you expect to collect 70% of those rent deferrals this year?

[Alberto Castillo, executive]

That's correct.

[Carlos Peyrelongue, analyst]

Okay. Great. And an additional question, if I may. With regards to anecdotal evidence of interest of clients coming from Asia moving to Mexico, either existing or new ones, can you provide any information on that regard?

[Alberto Castillo, executive]

Certainly. So far, we have -- by means of our communication with the -- not only with the property managers but also with some of our most important tenants, we see that some of them are realigning the supply chain strategy. And therefore, they're talking to some of the suppliers to try to relocate to North America. And many of them are in the Far East and that's how -- that's where the source of this information comes from.

In addition to that, we also have information from some of the -- of our broker community, that there are some site selection teams from either some American or Asian companies that have operations in China, that are kicking the tires in several markets to see if they relocate operations to North America. And certainly, and obviously, Mexico is the first choice for that.

So there is -- I think it's too early to say that we already started to see our operations, actual operations doing that. But the trend is certainly -- is in that direction.

[Operator]

Our next question comes from the line of Eduardo Alvizouri with GBM.

[Eduardo Alvizouri Alvarez, analyst]

I have 2 quick questions. The first one is if you could give us an update on the number of tenants that still haven't resumed operations.

[Alberto Castillo, executive]

Yes. The -- most of our tenants are starting the operations. I will say that with close to 100% of our tenants are in the facilities and are doing some sort of manufacturing. Because of some of them not being essential, perhaps they had to comply with some of the restrictions in the areas which they operate, they may not be operating at full capacity or at lower levels. But the feedback that we get from the market officers, from the property manager is that all of our tenants are in the facilities and are operating in their facilities.

[Eduardo Alvizouri Alvarez, analyst]

Great. And the second question is on collected revenues. Do you expect this number to continue deteriorating? Or do you expect in the second half of the year to recover regarding the deferrals granted?

[Alberto Castillo, executive]

Well, it's not -- I don't think we say -- the worry is not deteriorating. It's not deteriorating. I think that we have very good collection performance in that -- from the tenants, and we do not -- we have not received any additional request for rent relief. I think that it's not only that it's not going to deteriorate, but I think it's going to improve and with a lot of certainty, because all the deferral options that we gave to our tenants were documented and were signed. So it is a firm commitment from the tenants to proceed with the payments as agreed on the modification of the contracts to address this deferral.

So -- and I think -- let me point out that this collection has been very successful. The numbers that we use for collection performance refer strictly to what was invoiced in that period. If we are -- if we add to those collections what we received from previous periods, it will be at the high 90s, which I think it's something that perhaps we should have to clarify because our collections for the quarter, if I was to add this, what I just said about the collection compares to quarters, it will be in the high 90s.

[Operator]

Our next question comes from the line of Francisco Chávez with BBVA.

[Francisco Chávez Martínez, analyst]

I have 2 questions. The first one is regarding the Bajio region. We continue to see some downward trend in occupancy. When do you expect this market to stabilize and to see any change in this dynamic?

And the second question is on the leasing activity for the rest of the year. What do you expect, in terms of CapEx requests from tenants in terms of retention?

[Alberto Castillo, executive]

Sure. Thank you, Francisco. Yes. First of all, yes, the Bajio is -- it's a smaller market. It's a market that was very much affected by the pandemic. But also that we see a recovery from the auto sector, especially. And also we have some logistic distribution tenants that also are restarting their operation with a higher dynamic than we expected.

So to answer your question, we feel that the Bajio is going to recover in the next 2 quarters before the end of the year. And that it's going to -- and that will be reflected also on the occupancy in our portfolio.

And the second question, in terms of the leasing activity, we see very good momentum on the renewals of the expirations. And the request from the tenants for CapEx are standard, are [ normal ]. We don't see an increase on a special request from our tenants in order to renew the contracts. So that's why we stand by our guidance in CapEx for 2020.

[Operator]

Our next question comes from the line of Vanessa Quiroga with Crédit Suisse.

[Vanessa Quiroga, analyst]

I would like to ask about the guidance to understand it better because Terrafina kept guidance as it was originally announced. But we see that the cash collections are affecting FFO, and you are basing the payout ratio for the dividend on that cash FFO. So I want to make sure that I understand correctly how is it possible that Terrafina is keeping dividend guidance as originally expected, even though we are seeing some impact in terms of cash collections.

[Alberto Castillo, executive]

Certainly, Vanessa. Thank you very much. Good to talk to you, and I hope you're well, too. Yes, we stand by our guidance for one reason mostly. Because as I mentioned before, the deferrals concessions that we gave to our tenants imply that they are going to pay the deferred rent during the second half of 2020, as I mentioned before.

If you remember, we also reduced the payout ratio to 85%. And that is reflected also on our guidance for the DPS. And so that's why we do stand by our guidance. In addition to that, we also put in motion some activities to reduce costs or to defer also some nonessential expenses that are going to allow us to continue to have -- to stand by our guidance.

As I mentioned before, that -- those 2 elements are the main factors by which we're going to be able to maintain our guidance. We expect the DPS to increase during the second half of the year because of the payment of the deferred rent concessions that we gave to our tenants.

[Operator]

Our next question comes from the line of Jorel Guilloty with Morgan Stanley.

[Wilfredo Guilloty, analyst]

So I have 2 questions focused on the deferrals. One, I wanted to get to a sort of understanding as to what type of client is getting these rent deferrals. Obviously, not going to specific renters, but sort of the type.

And then the second question is how do you think about the receivables on these deferred rents? I mean because you're breaking it down where 70% of the deferred rent is going to be paid in the second half '20 and then the other 30% is going to be paid in 1Q '21. So at what point do you consider writing that down? What needs to happen?

[Alberto Castillo, executive]

Certainly. Well, first of all, we are not writing down any of that because, as I mentioned before, this -- we reached an agreement. We put -- let me take myself back -- we put in motion a protocol by which we formalized a conversation with the tenants' request for deferral, and we negotiated that deferral. It was an agreement with which we signed an extension or a modification to release contract, which we stated very clearly that they -- that we were not going to be collecting the rent for the months of, let's say, April or May or June, but they were going to -- the commitment to pay that during the second half for the year, the 70% that I mentioned before, or in some cases, it went all the way to the first quarter of 2021.

So that's why we don't have any plans, any intention to write it down, unless there is a -- they don't honor the commitment, in which case it will be a different treatment. We will do that as a breach of the contract, which is unlikely for that to happen.

So that's why we expect to collect that, and we are not planning on writing that down for that reason.

The answer to your question just to the deferrals, yes, I think there was a spectrum of tenants that requested the deferrals. Once we really start reach -- once we start talking to those tenants, many of them, they dropped their request and they pay the rent. But to the ones that we gave the deferral, were some in automotive. There were some in aviation. And there also -- there were some in the logistics and distribution sector. So I wouldn't single out a one type of tenants. But again, it was -- at the end of the day, it was about 30% of our tenants that we reached agreement with that.

[Operator]

Our next question comes from the line of Enrique Alcantara with Citi.

[Luis Enrique Alcantara Medina;Citi;Analyst, analyst]

My question is on the border market. Do you think that the border market is preparing in terms of supply for the expected upcoming -- due to the nearshoring? And what do you think could be the region that could benefit more of this nearshoring situation?

[Alberto Castillo, executive]

Certainly, Enrique, thank you. Well, to answer your question, yes, the border, as you know, in the market, especially in Juarez, in Tijuana, well especially in Juarez there's land -- there's the participation of several very good industrial restate developers that have, in motion, some starts of buildings on spare building on some of them. So I think that the border is well prepared to absorb some of this additional demand that is going to come because of the nearshoring.

The market that would benefit the most, I would say, will be Juarez, will be Tijuana. Certainly, Monterrey is a market that is also prepared to capture some of these opportunities. So I think that, to answer your question, yes, we're very prepared.

Also, there are some announcements of some very large investments from large -- for example, there's an announcement from Amazon that is going to start a huge facility in El Paso across the border from Juarez and that is going to add some momentum also to the infrastructure -- to logistic infrastructure in the border. And so I think that the border region, the northern region of Mexico is one that is going to benefit the most from this nearshoring.

The Bajio, also because of the participation for the auto industry, and some of the restructuring of the supply chains in some of the auto industry also, I think that the Bajio is going to benefit from that. So I would say that mostly in terms of nearshoring, it will be in other region first and certainly the Bajio region.

[Operator]

Our next question comes from the line of Froylan Mendez with JPMorgan.

[Fernando Froylan Mendez Solther, analyst]

I was wondering if the terms of the contracts with those tenants that you reached concessions changed in any way. I mean were there any gains for you for giving them deferrals, maybe longer leases, less DIs going forward? Any detail on that?

[Alberto Castillo, executive]

Sure. That's a very good question. Yes, we offer that. I think that as an effect, we -- part of the conversations with the tenants that request some kind of relief were that we wanted to assess what the situation was with the plant and what was the needs and how we reach -- so it was a contract or a negotiation that was tailored to each one of the needs of the tenants. And indeed, in some cases, there were some free rent granted for them for -- because there was a renewal that was a recent renewal. And the free rent was going to be exercised, let's say, next year or in the following 24 months. And then we brought that, call it, free rent to April or May. So that was part of the agreement.

In other terms, there was -- there were also a couple of instances in which we had expansions in motion, and we use that also as an opportunity to materialize that expansion, and that -- and extend the lease if we were -- for the expansions.

Surprisingly, what we -- when we start negotiating with some of these tenants, we thought that we were going to put some of the expansions on hold because of this. But some of the tenants -- but the expansion that we have already in motion was requested by the tenants to continue with the expansion. So part of the conversations were that not only they were going to pay the rent, but they wanted to, on a deferred rates, but they wanted to continue with the expansions.

So to answer your question, yes, there were conversations with some of them about -- if we were going to extend the lease or we -- if we had to put some investments in place in order for the contract to be extended or to increase the rent. All of these were a part of the conversations.

[Operator]

Our next question comes from the line of Armando Rodriguez with SIG Research.

[Armando Rodriguez, analyst]

Well, I have a question maybe for Carlos. Can you give us a little bit more comment, Carlos, on the fiscal result? And I don't know if this quarter, the fiscal result has an impact considering the relief that you comment, with your tenants, particularly with the FX and interest rate movements. And what's your view in the following quarters on this side? That's one question.

[Carlos Espinosa, executive]

Yes, Armando, thank you very much for your question. Well, yes, of course, we evaluate every quarter our tax result, and we make a projection towards the end of the year. Although since there is a lot of volatility still in the market, we are very prudent and very conservative in the decisions that we take. So we are making this -- the dividend that we are giving to our investors on this quarter is still going to be a tax result payment. And we don't expect it to change for the next quarter.

So on regards of the fluctuation of our -- of the foreign exchange rate, we really consider it part of the tax result, and it's going to be considered for the end of the year. So really, none of our projections have changed much. And we are still doing the same payment of tax results.

[Operator]

Our next question comes from the line of André Mazini with Citigroup.

[André Mazini, analyst]

My question is on something you touched upon already. So the development CapEx, just to confirm, this is CapEx with clients that you already have. So none of this will be in spec buildings, right? You do have clients for all of the new GLA that is being built this year? And if you can talk a little bit about maybe the geographies, and if this GLA is in expansions of current buildings or new buildings altogether.

[Alberto Castillo, executive]

Certainly. Well, the answer is both. This $25 million is going to be used to fund expansions. You're correct, mostly expansions, but also if an opportunity for a build-to-suit comes along, we will do that also. We -- as you remember, we do not -- we're not involved in any spec construction. We will only use that for expansions in build-to-suits. And in the build-to-suits, it may be also for a new tenant. Most of the expansions, of course, are for the existing tenant. There also been some build-to-suits for existing tests, but the possibility and the allocation of some of that CapEx to go to a new tenant, it's also a possibility.

And the region in which that has happened is mostly in the northern part, and also there's a couple of them in the Bajio.

[Operator]

Ladies and gentlemen, at this time, there are no further questions. I would like to turn the floor back to management for closing comments.

[Alberto Castillo, executive]

Well, thank you very much. Thank you very much for attending today. I would like to finish the call by stating we are still confident that our asset class will outperform during the highly challenging economic situation we're facing. We will continue to work together with all of our stakeholders to make sure we are well aligned with them, optimizing the results for everyone. We look forward to speaking with you all again soon, and have a great day. Thank you very much.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.