CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Transcript 2023-Q2

[Operator]

Good morning. My name is Jenny, 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] Thank you for your attention. I will now turn the call over to Francisco Martinez , Terrafina's Investor Relations Officer. Please go ahead.

[Francisco Martinez, executive]

Thank you, Jenny, and good morning, everyone. Welcome to our second quarter 2023 conference call. And we are 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 our financials.

So before we begin, we would like to refer you to the note on forward-looking statements in the quarterly report. For any information expressed or implied in the call may include forward-looking statements, which could involve certain risks and 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 this call 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, and the company has no intention 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, please go ahead.

[Alberto Castillo, executive]

Thank you, Paco, and good morning, and thank you for joining us today. As we have seen over the first half of the year, the industrial real estate sector in Terrafina has had an extraordinary performance. High demand in primary markets has maintained occupancy at maximum levels in rental rates growing. This has supported our organic growth through double-digit leasing spreads. Supply remains healthy as new developments in some markets continue to face challenges regarding access to energy and water. Nevertheless, new GLA continues to be delivered for new and long-term tenants committed to invest in their operations, thereby growing their production lines with expansions or build-to-suit facilities.

Not only do we maintain our positive view on primary markets, but are also quite enthusiastic about secondary markets. We have started to see a spillover effect in those areas and locations like Tijuana, Ciudad Juárez, and Monterrey continue experiencing record low vacancy levels. Chihuahua, Ramos Arizpe, Derramadero and Reynosa are good examples with strong performance. Irapuato region follows. As in this quarter, we reached an 89.8% occupancy, supported by higher leasing activities in the Silao market.

Nearshoring remains a crucial element of the industry's growth story. It continues to be supported by the automotive sector, where Terrafina has a strategic exposure to tenants that play an important role in the manufacturing of EVs. Aviation sector also plays a key role as a solid industry where state-of-the-art manufacturing facilities in Mexico grow with aviation tenants requesting additional space to meet their production goals. The electronics industry is also relevant through the manufacturing and assembly of electronic components, among others. As we mentioned before, keeping up with new demand represents one of the greatest challenges for the industry. This is why at Terrafina, we continuously look for opportunities where we see growth. Having said that, we are about to start our sidecars capital deployment with the closing of a relevant acquisition of properties that are strategically located in the Northern and Central regions. We will be sharing more information on this very soon.

On the financing front, I also have excellent news to share. As you might have seen recently, we closed a new sustainable credit facility for $500 million that will replace our existing revolver in term loan facilities that add up to $485 million. As a result of Mexico solid industrial real estate fundamentals and Terrafina's strong performance, our funding terms improved with this sustainable credit facility. The transaction was led by PGIM Real Estate and is closely aligned to our ESG goals, which are continuously improving. We reiterate our commitment to aligning our strategy with our stakeholder priorities. The progress we have made in ESG has allowed us to generate savings in our funding as well as the case with this credit facility. We have also been able to improve our capital structure with better average maturity for our debt.

Moving on to our results for the quarter, let me share some key highlights. Consolidated occupancy reached 97.3%, a new record high for Terrafina, thanks in part to a 94.8% retention rate on renewals, 14 contracts out of the 18 that had to be rolled over were renewed during the quarter. The remaining 4 that were not renewed had already been leased. This comes to show how strong demand for industrial space is right now.

As for our leasing activity, we signed 1.3 million square feet of renewals and 600,000 square feet of new contracts. The Northern region had the most leasing activity representing 49.8% of our contracts. Ciudad Juárez, Ramos Arizpe and Chihuahua led the way with these solid -- with this sold-out markets with an average occupancy of 100% in a rental rate of $5.90 per square foot per year. Tenants in electronics and auto component manufacturing accounted for the majority of the Northern region's activity where some participation was also visible in the aviation sector. The Bajío region was a positive surprise this quarter as we saw an important recovery in the overall occupancy. The leasing here was 34% of our total leasing activity, mainly concentrated in the Silao and Guadalajara markets. These tenants mainly belong to the logistics and distribution sectors. The average rental rate was $5.80 per square foot per year, and the average occupancy was 89.8%.

Finally, in the central region, the Cuautitlán Izcalli and Toluca markets reached 99.1% average occupancy rate and an average rental rate of $6.50 per square foot. These markets continue to be dominated by logistics and distribution. The average leasing rate per square foot for all leases that were signed during the quarter was $6.58. This implies a 29.8% 12-month trailing leasing spread. Our net asset value per certificate increased 8.7% year-on-year as demand for industrial space continues to grow. And finally, our FFO per certificate for the quarter grew 4.2% year-on-year as we start to see our growth strategy benefits play out with new developments starting to generate rent revenues. Thank you for your time. And please, Carlos, go ahead with the financial highlights.

[Carlos Espinosa, executive]

Thank you, Alberto, and thanks to all the participants for joining us on today's 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 only included in the AFFO.

To start, our collections and rental revenues reached $54 million and $53.9 million on a 10.4% and 10.6% year-on-year increase, respectively. This increment is explained by the contribution of rents from new developments that have been delivered as part of our 3-year growth strategy. NOI was $50.8 million, an 8.7% year-on-year increase on a 93% NOI margin. We had a 16.8% year-on-year decrease in operating expenses. Mainly in recurring maintenance expenses, which further strengthened our NOI result.

This benefit flowed through our EBITDA, which reached $44.5 million. This is a 7.8% year-on-year increase and implies a solid 81.5% margin. Our FFO increased 4% versus the second quarter of 2022 reaching $32.5 million on a 59.5% FFO margin. All in line with our expectations. FFO per certificate had a 4.2% increase compared to the second quarter of 2022, totaling USD 0.0421 per certificate. This is the result of the positive effects of our 3-year growth plan. Finally, AFFO reached $27.5 million, which implies a 1.2% year-on-year increase. Distributions were $19.3 million or USD 0.025 per certificate. This is in line with our plan to distribute USD 10 -- USD 0.10 per certificate for the full year.

Moving on to the balance sheet. We closed the quarter with $27.7 million in cash. Our investment properties closed the quarter at $2.8 billion, and our total debt at the end of the quarter closed at $918.1 million. Our average cost of debt closed at 5.52% and our average weighted maturity of debt was 5 years. Finally, our LTV closed at 32.3%, in line with the 35% guidance. It is important to mention that because of the new sustainable loan issuance we expect to see improvements on our overall cost of debt. This will have a positive impact on our bottom line FFO and AFFO. Thank you for your time and attention. I will now ask the operator to open the line for questions.

[Operator]

[Operator Instructions] Your first question is coming from Pablo Monsivais from Barclays.

[Pablo Monsivais, analyst]

Just have 2 questions quickly. The first one is -- and Alberto you say that soon you're going to disclose more information about this but do you have anything interesting to share about the sidecar. When do you think we'll start to see something or the size or if it's just -- any more color will be very useful. And my second question will be on the Bajío, it seems like the region is improving significantly. Can you please share with us like which tenants are moving to Bajío, should -- is this just because of the northern markets are constrained or it's because clients are looking for very specific reasons to be in the Bajío?

[Alberto Castillo, executive]

Thank you for your question, Pablo. And first -- well on the first one, yes, let me say that we have made substantial progress on the capital deployment of the sidecar, and we will announce very shortly a very a very relevant acquisition of properties in the northern part of Mexico and some in the central around Mexico City. I think that this -- we stated when we talk about the sidecar, the investment period was going to be between 2 and 3 years, and I can tell you now that this will be substantially shorter than that. I think that we -- not only we had a very robust pipeline of opportunities for Terrafina, Terrafina display of the sidecar. If you remember that about 85% of the proceeds from the sidecar are going to be used for acquisitions in the maquiladora program. So we will announce very soon this acquisition. And I can anticipate also that there's additional opportunities that are going to help us to materialize the capital deployment sooner than what we had anticipated. So expect some good news soon.

In terms of the Bajío improving, I think it's a matter of both things that you mentioned. On the one hand, I recently had information about the initiative from developers in Querétaro that are very close to deploy a strategy to add electricity to that city. The -- there are several companies that are waiting on the sidewalk to start investing in Querétaro and the holdout has been the lack of electricity. Unfortunately, it seems that there are some people with greater ideas about how to solve that issue and that is going to help Querétaro. The same is happening for San Luis where we also have information from our market officers that the auto industries are going to announce also some plans, and they are in negotiation with the government to fulfill some of their needs for electricity. So there are some good prospects to -- on the Bajío to improve.

Of course, a lot -- some of this also has to do with the fact that there are some tenants or some companies that have operations in the border. And because of the fact that this is sold out in terms of real estate space, but also additional issues that had to do with more stable labor force on the interior of Mexico and perhaps even lower cost of operations, including labor, rent and access to infrastructure that may -- or that is going to be an opportunity for the Bajío region to continue to improve. We're optimistic about that. Of course, as I mentioned before, we are not going in the Bajío. All of the investments that we're doing either on the -- what we did on developments on the 3-year plan and the sidecar are going to be in the primary markets like Tijuana, Juárez, Monterrey, around Mexico City. But Bajío continues to have -- to present some opportunities.

[Operator]

Your next question is coming from Francisco Chávez of BBVA.

[Francisco Chávez Martínez, analyst]

Congrats for the strong results. I have 2 questions. The first one is regarding the lease spread. How sustainable is this lease spread for the coming months and particularly in the Bajío region? And the second question is a follow-up of Pablo's question. I saw that in your balance sheet, you made an acquisition prepayment for around $10 million. Is this item in your balance sheet related to the sidecar?

[Alberto Castillo, executive]

Very good. Well, the first -- thank you, Paco, for your questions. And the first -- yes, the lease spreads are going to continue. As we all know that the environment changed in terms of the price of the leases. So as we had some very positive lease spreads on the renewals of the expiration this quarter, I think this is going to continue. And in the Bajío -- to answer your question, the Bajío, yes the Bajío also is going to -- is already showing signs that it's going to experience. What is happening is that our tenants have realized that this environment change, and they are willing to pay the additional price of the leases, especially in the manufacturing for export. Because manufacturing for export, as you know, these tenants have invested a substantial amount of resources on their facilities on ASTI. They -- if they are happy and they're comfortable with the labor force that they have and the connectivity of the facilities it's more than likely that they're going to renew, and they will accept the increase in rent as the rest of the markets have changed. In terms of that amount that you mentioned on the balance sheet, it was an escrow account that we put in order to secure a deal of an acquisition that we're going to close very shortly. And this is what I referred as in the next weeks, we're going to make an announcement of this substantial acquisition that we're going to make with the resources of the sidecar.

[Operator]

Your next question is coming from Juan Ponce of Bradesco BBI.

[Juan Ponce, analyst]

My first one is on your expectation on cap rates for the second half, particularly in the northern region. And also regarding the land bank, which is expected to be used in the sidecar, how much of it already has this necessary infrastructure such as energy, water to begin building?

[Alberto Castillo, executive]

Yes. In reference to the land bank that we are going to use for development of investment in the sidecar, we do have the electricity, and we do have the entitlement and everything is ready on those -- for those developments. This land bank is going to -- is the one that we have in markets like Monterrey and Ciudad Juárez. So -- and again, as I said you, on this is land that we have had for some time in those stretch of land are ready to be developed.

[Juan Ponce, analyst]

Okay. And do you have any expectations on where you see cap rates in the second half?

[Alberto Castillo, executive]

Oh, the cap rate, yes. The cap rates are going to be around 7%. As you know, there was some compression on the coverage during the last part of last year and that -- but then they reached an inflection point, and I see that they are retaining around the 7%.

[Operator]

Your next question is coming from Renata Cabral of Citibank. Renata? Okay. We don't appear to be able to hear Renata. I'm going to take a question. The next question is coming from Gabriel Himelfarb of Scotiabank.

[Gabriel Himelfarb Mustri, analyst]

Can you give us a bit of color on the possibility to increase the guidance for this year and next year due to better organic income? And also, can you give us some color on the gap between market rent and in-place rent? Do you think that will continue or will market rent -- will in-place rents will reach market rent in about how much time?

[Alberto Castillo, executive]

Yes. Thank you, Gabriel. Well, first, in terms of the guidance, we stand by our guidance of USD 0.10 for 2023. If there are some developments or something that weren't that we do that, we may do that in the third quarter. But at this point, we stand by our guidance of the USD 0.10, and that we distributed evenly at $0.025 per quarter. In terms of the market rents, we are precisely achieving this rent growth at the time of renewal of the expirations based on this increase on the markets rents. And we think that these market rents are going to continue to increase in some markets. Although there are some opportunities to have mark-to-market in our portfolio. And we are experiencing them at the time of renewal. Certainly, the new contracts are already being signed at those high market rents, as an example of the leases that we signed in Tijuana, which were above the $8 per square foot per year and as well as the ones that we signed in Ciudad Juárez that are between the $7.50 per square foot per year as compared to what we had a couple of years ago that were in the $5.50 to $6. So these market rents in our opinion, are going to continue to gradually increase not as dramatically as they did on the second part of last year and the first half of this year, but indeed, this -- there continues to be a correction on the rents in -- for leases in Mexico as compared to other parts of the world.

[Operator]

Your next question is coming from Juan Macedo of GBM.

[Juan Pablo Macedo Carrillo, analyst]

My question is -- well, it's 2 questions. My first one is regarding GLA. We saw some additions in the Chihuahua, Juárez markets. Could you give us some color on that? Is it related to the partial incorporation of developments? And my second question is regarding cash flows. We saw some cash inflows from dispositions. Could you give us a detail from where did that come from?

[Alberto Castillo, executive]

Sure. So in terms of the first question, yes, the additional GLA on our portfolio in Juárez in Chihuahua comes from development. Indeed, we finish the development of 3 facilities in Ciudad Juárez. Two of them were already leased. The second one is already cash flowing. The other is going to start very soon also. And that was the result of the development in our own land as part of the 3-year growth plan. In terms of the cash flow, can you repeat the question on the cash flow, please?

[Juan Pablo Macedo Carrillo, analyst]

Yes. On the cash flow sheet, we saw some cash inflows from the disposition of properties. Could you give -- yes, okay.

[Carlos Espinosa, executive]

Yes. Yes. There's -- here, we had -- we sold a small piece of land. So that's where you see this. And also the other disposition that you saw is another piece of land that we contributed to our -- one of our JVs that is located in Monterrey. So those are the 2 dispositions of the quarter.

[Operator]

And your final question is coming from Felipe Barragan of BTG Pactual.

[Felipe Barragan, analyst]

My question is on developments. So you guys noted earlier in the call that perhaps the sidecar would end earlier. And then also said cap rates were -- they had compression and may sort of extend in recent months. What is your take following these acquisitions with the sidecar. Do you guys think maybe perhaps developing would be a reliable route, especially with other firms in the industrial real estate sector are starting to go into developments. What is your take on that? Do you guys consider acquisition's still the main route to take for the firm?

[Alberto Castillo, executive]

Yes. Thank you for your question, Felipe. Yes, and an opportunity to explain because, of course, the development yields are better than the coverage for acquisition. Indeed, we have made -- do developments many times and we know how to do it, and we think it's a very good opportunity. However, in this environment, in which there are some headwinds for development in terms of the availability of infrastructure in some of the markets where we want to expand. There's also some very high barriers of entry in terms of land is very scarce. It's difficult to develop and that it's very expensive. We saw an opportunity to acquire facilities from emerging developers that are in those primary markets that already have developed and stabilized properties. And that -- and we think that we can acquire those at very good market cap rates and include them in our growth plans very quickly. And that's why we dedicated 85% of our proceeds from the sidecar for these acquisitions. As I mentioned before, we're very close to finalize a couple of very relevant acquisitions in those markets, in the markets of the North and around Mexico City that are going to be very accretive. The other 15% of the proceeds from the sidecar indeed, we're going to do for development in areas in which we already have land with all the infrastructure and that -- and again, these are going to be in the primary markets. So that is the strategy behind the mix of development and acquisitions.

[Operator]

Well, we have reached the end of our question-and-answer session. I will now turn the call back over to the management for closing comments.

[Alberto Castillo, executive]

Thank you, Jenny, and thank you all for joining us today. In closing, I want to express my sincere appreciation to all of you for joining us today. The first half of the year has been exceptional for Terrafina. High demand in primary markets supported by organic growth and strategic investment has led to record high occupancy levels and positive leasing activity. Our commitment to ESG goals has not only resulted in a new sustainability credit facility, but also improved funding terms. We are optimistic about the future, continuously seeking growth opportunities and confident in our ability to deliver value to our stakeholders while contributing to the industry's sustainable growth. Thank you all for your continued support, and have a great day.

[Operator]

Thank you, everybody. This does conclude today's conference. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.