CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Transcript 2020-Q4

[Operator]

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

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

[Francisco Martinez, executive]

Thank you, Alex, and good morning, everyone. Welcome to our fourth quarter 2020 conference call, and we are pleased as always to have with us here today from Terrafina, Mr. Alberto Chretin, Chief Executive Officer; and Mr. Carlos Gomez, Chief Financial Officer. Alberto will have -- take us through the company's overview and operations, and then Mr. Gomez will discuss the financials.

Before we begin, we would like to refer you to the forward-looking statement as further noted 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 such 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 out of the company's control. These comments represent the company's judgment at the time of this call. 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 Castillo, executive]

Thank you, Paco. Good morning, everyone. I'm pleased to be here sharing with you our fourth quarter results, which, despite a complex set of challenges derived from the pandemic, were very robust. Our portfolio was able to surpass our modified guidance and overall delivered positive trends on key performance indicators. We can explain our resilience with the following factors.

Throughout the year, we were able to work together with our tenants on our rent relief program. This program was very successful as rent deferrals had been recovered in a timely manner, leading only to a minor impact on our cash flow, which represented less than 1% of our annual rental revenue.

Our leasing activity remains strong as a result of the proactive teamwork of our external adviser, PGIM Real Estate, and our property managers. We were able to lease a total of 8.6 million square feet, which represents 22% of our total G&A. Out of 102 contracts that matured during the year, 84 were successfully renewed. If we combine this with the early renewal activity, our renewal rate closed at a healthy 89.9% in the fourth quarter. Our occupancy rate remained in the 95% range, and our actual rental rate per square foot closed the year at $5.28 as a result of the asset sales. Looking at the same-property rental rate, we closed the year at $5.22 per square foot per year.

We successfully executed the sale of older properties located in nonstrategic markets. This provided new resources to strengthen our balance sheet. And going forward, we will be able to benefit from this added flexibility by means of new developments.

On the development front, we built 692,000 square feet of GLA throughout the year at an estimated yield on cost of 10.4%. Our ability to deliver build-to-suit properties as well as customized expansion projects has been crucial for repeated business with our tenants.

Overall, the manufacturing sector had its ups and downs in 2020 as partial and full closings were mandated as a result of COVID-19 pandemic for certain periods. Nevertheless, the second half of the year saw a gradual recovery which we foresee will we gain strength over 2021. We believe this will present new opportunities for Terrafina. We have actually already identified a couple of development projects which are expected to be launched throughout the year.

As we have said in the past, we intend to maintain a strong balance sheet and selectively invest in Class A projects in highly demanded regions targeting multinational tenants. We believe that demand for new space will also be triggered as nearshoring trends gain strength.

Looking ahead to 2021, we believe that the significant fiscal stimulus in the U.S. and the speed of its vaccination rollout supports our positive view for the manufacturing for export and logistics sectors, both core elements of our business model. We are encouraged by recent macroeconomic data which shows that the Mexican industrial sector is performing strongly, the one dry spot in an otherwise difficult year for the Mexican economy. We see our tenants' operations in good shape, and most of them expect a better year compared to 2020. We are obviously aware that the current government restrictions cool to a certain degree, and that allows some of our tenants to maintain their operations at full capacity in various regions. But having said that, we have not received any additional request for rent relief in the third quarter of 2020.

It is important to note that 7.2 million square feet, or 20% of our total GLA, will mature during 2021. Approximately 55% of these leases will expire in the first half of the year. Considering the macro environment and maintaining a conservative approach to our internal forecast, we expect an annual renewal rate in the low 80s percent. This means that we're budgeting a scenario of 1.2 million square feet of lease terminations. In our conversation with tenants in the past, the most common reason for not renewing has had to do with consolidation processes. In fewer cases, it has been triggered by their need to increase or decrease their current amount of space, which, in some occasions, we cannot accommodate immediately.

As for rental rates, we expect some of our lease renewals to reflect a onetime effect related to the amortization period of build-to-suit buildings and tenant improvement. It has been a standard practice to include in the renegotiations additional investments related to build-to-suits in above-standard tenant improvements in the overall rental rate. Once these fully amortized rents are adjusted to market rents, the overall change we expect will be for a total of $1.6 million for full year rental revenues. This will also be partially offset with the new developments we will be working during the year.

This led us to our new same-store 2021 guidance, which I'm happy to share with you. We estimate occupancy rate will be in the 94% to 95% range, already accounting for the lease terminations which we have budgeted for the year. We expect an annual net operating income in the $177 million to $178 million range, and we forecast annual maintenance CapEx of USD 0.30 to USD 0.33 per square foot for our total GLA. For annual distribution, we will maintain our 85% AFFO distribution payout ratio policy, which leads to a distribution per share between USD 0.1020 and USD 0.1030. Finally, for our growth strategy, we estimate $50 million that will be used for new developments and approximately $10 million for expansions. These activities will be financed with 15% of AFFO reserve and partially with the revolving credit facility.

Thank you for your time. And now I will pass the call to Carlos. So please 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.

During 2020, net collections reached $194.7 million and $49.1 million for the fourth quarter, a 3.2% decrease compared to the fourth quarter of 2019. I would like to remind you that for a full year now, Terrafina's main metrics have been presented on the rent 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 uncollected revenues plus collected revenue. This way, our distributions are more aligned to real cash generation from operation.

As for our annual and quarterly rental revenues, they reached $199.1 million and $48.5 million, respectively, which implies a 0.3% year-on-year decrease. NOI was $188.1 million, of which $48.1 million came from the fourth quarter, a 1.3% year-on-year decrease that implies a 94.2% NOI margin. Full year EBITDA totaled $168.5 million, of which $43.2 million were generated in the fourth quarter, demonstrated a 0.2% decrease and an 84.2% margin. Finally, a 2020 AFFO reached a total of $103 million with $27.2 million from the fourth quarter, a 12% year-on-year increase. Considering an 85% payout ratio, our distributions for the year is $87.5 million or USD 0.1107 per certificate. And our distributions for the quarter reached $23.1 million, which is total USD 0.0293 per certificate.

Moving on to our balance sheet. We closed the quarter with $72.4 million in cash. This means our leverage closed the quarter at 40.5% of fair market value and 37.7% on historical cost. Our debt service coverage ratio stands at a sound level of 4.1x. Our average cost of debt was 4.49%, and our average weighted maturity of debt was 6 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 André Mazini with Citigroup.

[André Mazini, analyst]

So my question is on the auto sector. We saw some pieces of news saying that most of the auto manufacturers, OEMs last week actually decreased production. Some of them actually stopped production outright because of the gas situation and energy situation. So how do you think this is going to be kind of resolved going forward? Do you see the auto manufacturers going to contingency plans in terms of energy? Of course, there's an energy reform going on, very controversial. So the question is, is this going to be a big pain point for the sector, which is the most important factor for you guys? How do you think the end game of this will be?

[Alberto Castillo, executive]

Well, thank you for these questions. But we basically have the same information that you have in terms of the OEMs. We consulted with our automotive Tier 2 and Tier 3 tenants. And of course, they are all concerned about what is going to happen with the OEMs. But so far, the feedback that we get from our tenants is that indeed, there was a hiccup on the delivery of their components, but these did not have a major effect on their operations.

But to focus on your question, I think that there is some uncertainty about how that is going to affect the OEMs. To tell you the truth, I'm not aware of any large contingency plans that the OEMs have in terms of how to address this. This is something that we're monitoring and that we have information from our tenants that it is an issue. But at this point, we don't know exactly what kind of contingency plans they are going to put in motion. Now I hate to remind you also that a lot of the Tier 2 and Tier 3 tenants that we have, so far, just a fraction of the -- or a portion of the production goes to the Mexican OEMs. A lot of them also export the majority of their components.

So in summary, I'm sorry to not -- I don't have a specific answer about what kind of contingent plans the OEMs have. I know it's an important issue and that -- and we'll continue to gather information on the issue.

[Operator]

Our next question is from Vanessa Quiroga with Crédit Suisse.

[Vanessa Quiroga, analyst]

It's related to your growth plans. So it's very good to see that you are taking these opportunities to expand the portfolio organically. Could we understand that this is your new or your current strategic view for that company's growth instead of acquisitions given the valuation of your shares? That's the question.

And the other one is for your developments, the ones that you have announced in your pipeline. Do you plan to use existing land that you have? Or do you expect to have to buy land?

[Alberto Castillo, executive]

Thank you, Vanessa, for your question, a very good question. Well, in terms of the growth, you're correct. I think that we identify opportunities to grow through development. As I mentioned, we have a couple of projects, one in the North, basically in Tijuana, one in the Central market in which we see opportunities to increase our presence in e-commerce and logistics and distribution.

We have -- and correctly as you mentioned, our growth is going to be through development. We -- at least not in the short term, we're going to stop the consolidation activities that we had in the last few years in which we were a consolidator of industrial real estate properties in private hands. We feel that we were very successful doing that at that time. But at this point, we're going to focus on the growth through development. Yes, we are going to use our existing land for a couple of these developments, but we also contemplate the possibility if we reach an agreement with some of our potential last-mile customers that we may have to buy some land. But if we do that, it will be very specific for a build-to-suit with a contract in hand that we're going to use that purchased land for that project. I don't know if that answers your question, Vanessa.

[Vanessa Quiroga, analyst]

Yes. Very good.

[Operator]

Our next question comes from Francisco Suarez with Scotiabank.

[Francisco Suarez, analyst]

Sorry. Can you hear me?

[Alberto Castillo, executive]

Yes.

[Francisco Suarez, analyst]

Alberto, it's a question for you. For as long as I can remember, you have wonderful contracts in -- among your tenants. I mean you have encouraged investment to the state of Chihuahua particularly. Any idea, considering your overall exposure to the auto industry, on how the absence of semiconductors may actually help you to promote new businesses to Mexico or otherwise perhaps the semiconductor scarcity and Biden's executive order may also be considered as a threat to relocate production to the U.S. rather than to Mexico? Any thoughts on that?

[Alberto Castillo, executive]

Sure. Yes. That's a very good question, Francisco, yes. We had a lot of conversations about what was going on with the semiconductors and the reason for the shortage, what's happened and then what are some of the potential answers to this issue and that -- indeed, you probably saw also that President Biden also recently made a statement about the fact that he's going to encourage companies to review their supply chains to have less dependency on foreign manufacturers. There are 2 very important semiconductor suppliers in the U.S. that are looking at expanding their operation in order for the industry -- well, not only the auto industry because, as you know, a lot of this -- of shortage was also triggered by the fact that there was a lot of consumption on other electronic uses of the microchips and the semiconductors, and that created the shortage for the automotive industry.

So to answer specific to your question, yes, I think there is an opportunity for Mexico to participate in that. However, in the opinion of some of the experts that we talk to, these are very capital-intensive investments. And it may be because of the request from President Biden specifically on this item, they may be manufactured in the U.S., the ones that are very heavy on capital investment. But also, there's also a potential for opportunities of those companies even to explore some opportunities in Mexico. So in fact, Intel is one of the main suppliers of these semiconductors. There was a time that they were looking into -- to do something in Mexico, and they may indeed do that again because of the added, perhaps, demand that they will have from the components for -- to make them in North America.

So it is an opportunity. It was an issue. It's something that we're constantly talking. We had a conversation with one of our Board member. You'll remember that Eduardo Solis, the former head of the Automotive Industry Association, we had a very in-depth discussion about this issue in that it may be an opportunity but also it may be an opportunity for North America.

[Francisco Suarez, analyst]

Got you. So in a way, if I understand correctly, this is an example of how important it is to make much more resilient the value of supply chains between the U.S., Canada and Mexico, and that may bring you more opportunities. However, in this case, because it is so capital-intensive and because of the considerations that are actually -- that you discussed in your -- on the first question, so my colleague with Citi, on the energy reform and so on, that may actually take a toll to move production of such facilities into Mexico, isn't it?

[Alberto Castillo, executive]

That is correct. That is correct. Unfortunately, that -- this is the one component -- as we already discussed, it's very capital-intensive and it's strategic not only in the auto, in appliances and electronics, but also for defense. So I wouldn't be very optimistic about the semiconductor production to move to Mexico at least at this time. However, it is an option.

[Francisco Suarez, analyst]

Got you. Last question, if I may add. Just to understand, where do you feel more comfortable within your overall geographic footprint in terms of overall net absorption? Is it along the U.S. border? Is it much more in the Bajio? Or is it -- relates actually with your strategy linked to moving more to logistics and e-commerce?

[Alberto Castillo, executive]

Yes. Well, this -- we think that the North region is one that has a better absorption, which you probably know that -- you know that we have a participation in Tijuana, and we're looking to expand our presence in Tijuana. We also have projects ongoing with expansions in -- we're delivering a build-to-suit in Juarez. So it's more in the North. And when we look also at opportunities for e-commerce -- as you know, we have our industrial park in Cuautitlan Izcalli, where we have almost a little bit over 6 million square feet, and it's 100% occupied. So we're looking for opportunities there. We do have a couple of attractive lands in that area that we are exploring the possibility of expanding there. So to answer your question, it's the North market and the Central market where we see more opportunities.

[Operator]

Our next question is from Froylan Mendez with JPMorgan.

[Fernando Froylan Mendez Solther, analyst]

This is Froylan from JPMorgan. Alberto, do you have more specific details on the expansions like GLA, CapEx and maybe timing of the contribution that we could expect this year?

And secondly, you also spoke about the renewal rate that you expect for this year. I might have missed some of the details, but can you tell us how this compares to previous year and if that is deteriorating or why making an emphasis this time?

[Alberto Castillo, executive]

Yes. Thank you as well. Yes, well, the CapEx for expansion is going to be about $10 million. And this is also dependent on the confirmation from some of our tenants that have expressed interest in expanded facilities. So that's about the order of magnitude of what we expect to do expansions with our current tenants. In terms of the renewal rate, I did mention that we have, this year, a number of contracts in which we -- that we are going to renew this year that have a component of above-standard tenant improvement on their original lease contract. And once those -- when those special improvements amortize, there's going to be a mark-to-market on the rent. And so that -- so we identify those.

And let me just use this opportunity to tell you that we review -- in our budget for 2021, we review in detail each property that is going to roll over. And we also made an assessment of what kind of investment or TI we have to invest on that building. And also, we made an assessment of the probability and the conditions that -- which this is going to renew. And that's when we see that in some contracts that are rolling over this year, we had -- a portion of the rent was amortizing during the initial contract. And then once our initial contract is finished, in order to renew that, we need to adjust the rent to address the issue that the above-standard tenant improvements or the build-to-suit -- special investment in the build-to-suit were amortized. And therefore, we had to reduce the rent.

And that -- we want to share that with you because that is something that is going to happen this year. At the end of the day, we're going to have that in terms of the overall performance because I think some of these reductions that we may have to provide in some of the very specific contracts are going to be offset by the fact of the new developments that we're going to make. I don't know if...

[Fernando Froylan Mendez Solther, analyst]

Yes. No. Very clear -- yes. No. Definitely. If I can just add on that, do you have an idea how much the above-standard TIs represent the overall rent on average? And if you have an idea today of your whole portfolio, what percentage of your leases have that, let's say, above-market rent because of these TIs?

[Alberto Castillo, executive]

Well, this is -- at this point, we think that this -- some of the contracts that we analyze this year are the ones that we just mentioned, which is going to be an impact of about $1.6 million at the end of the year, which we expect to offset with some of the -- of developments that we make. But in terms of how many of those, I think that this is something that we do on not only regular basis but on some instances. And we don't think that at this point, we can give you a very precise information on how many they are. This is a normal way of business. We have been doing this since we start. So I don't think it's going to be -- it continues to be significant. This year, it does make an impact. We will let you know later on how much of that is going to impact in the future.

[Operator]

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

[Wilfredo Guilloty, analyst]

So I have 2 quick questions. One, so the divestments that you did in November, among the regions that I focused on was on the Bajio. About half of the divestments were there. And that is actually the region that has been underperforming vis-à-vis the North and the Central region. And so what I was trying to gather is, as you look at your quarter going forward, is this a sort of portfolio realignment you'd like to do going forward, as in divest more from the Bajio and focus more on the North and Central regions? Or was that just happenstance because of the constitution of the portfolio that it happened that way?

And then the second question was around the supply-demand dynamics. The Northern region is seeing healthy demand, different reasons, onshoring, reshoring, the economy heating up. I just wanted to get a sense from you as to how you're seeing potential development pipelines. Are you seeing -- or do you have any perception of an increase in pipelines from competitors, other third parties? And does that worry you at all as to what the possible supply issue can be maybe 2, 3 years down the road?

[Alberto Castillo, executive]

Okay. A very good question. Well, first of all, in terms of the dispositions, yes, I think that the reason behind the disposition was precisely to focus more on the most active and most important markets. So part of the strategy has been that, and it may continue to be in the future. So when we assess -- when we analyze a portfolio to sell a portfolio, we take into account what you just mentioned, the location of the buildings, certainly the profile of the real estate, characteristics of the building and that -- and the amount of TI that we had to invest in -- when we're going to lease the facility. So yes, that -- this time, we're going to focus more on the most important markets. As I mentioned, we're doing developments in Tijuana. We do have a lot of things in Juarez. We don't think that we're going to go into new markets, but it's going to be the -- obviously by means that we're going to a path, get out of some secondary or tertiary markets.

In terms of the supply and demand in the markets, right, we see that as positive, the fact that we have good absorption in the markets in which we operate. And we also see as a good sign also the fact that some industrial real estate developers are being more prudent when they come to the developments. There is less [ spec done in ] construction in the market. And the industrial real estate developers are more cautious when we -- when they go to build facilities for -- to address that demand. And at the end of the day, we feel that is positive, that the supply is very much matching the demand. And eventually, there are times it may be that some of those private industrial real estate developers may be a pipeline also for acquisitions for us in different scenarios. I have to say that.

[Operator]

Our final question is from Yejide Onabule with Barings.

[Yejide Onabule, analyst]

I'm just -- I joined the call a bit later. I must have missed some answers. Well, the first question is around your outlook for 2021 for your business. What is the outlook in terms of occupancy levels? Are you expecting higher, lower occupancies in 2021? Are you giving discounts to any of your tenants in terms of the rent renewals that you have this year? Are you finding it easy to be able to renew those rents in terms of lease rates? Do you still think that you can get lease rates higher than inflation? Just to get a sense for what the business is going to be like in 2021.

And then my other question is on funding. Obviously, you have a 2022 bond. I think it's a small scrap. Just trying to understand, well, your funding needs. Do you think you might need to tap the bond market in terms of the liquidity that you have? It's only -- I think you said it was $72 million of cash. Is this sufficient enough to run the business? Do you require more funding?

[Alberto Castillo, executive]

Yes. Well, thank you very much for your question. In terms -- yes, in terms of the performance of the portfolio as -- I did mention that the occupancy is going to gravitate about -- between the 90%, the 94% and 95% and that this next year, this 2021, we're going to roll over, over 7 million square feet or about 20% of our total G&A and that we -- the renewal rate for 2021 is going to be on the low teens. We are budgeting a scenario in which we're going to have about 1.2 million square feet of lease terminations. We are considering that also in our budget for income.

So we think that what is going to happen also in terms of rental rate is that there's going to be a slight reduction because of the -- contracts that expire this year do have a component of above-standard tenant improvement that is amortizing over the period of the first lease contract. Once this contract that we're going to renew is renewed, we had to adjust or we had to reduce the rent because of the amortized initial investment that we have on the building. So -- but at the end of the day, it's going to be similar to what we have during 2020 because we are thinking that we're going to offset some of these reductions in rent with the new developments. And I don't know if that answers your question.

And your second question in terms of the amount, we're going to spend about $50 million in new developments and approximately $10 million for the expansions. And we are going to fund these expansions through the 15% AFFO reserve that we -- you remember that last year, we changed our payout ratio from -- from 100% to 85%. And indeed, we partially fund this expansion with the revolving credit facility.

[Yejide Onabule, analyst]

In terms of 1.2 million square feet that are not going to be renewed, what is the reason why they're not going to be renewed? Are you seeing any pressure on any particular group of tenants?

[Alberto Castillo, executive]

No. The reason why we're not going to renew this -- and again, this has to do -- and I mentioned also before that we analyze each one of these expirations of the contracts and we see the reason for that. And the reason for that are consolidation. Most of the time, it's because a tenant -- we have several tenants that have multiple facilities. So sometimes, they consolidate that in one facility. Other times, it's because they require -- they need -- because of their growth or because of the new requirements, they need a smaller or a large facility that we cannot accommodate at the time.

So to answer your question, no, we don't have any pressure from any group specifically. This happened to be -- this is when you lease facilities and the needs of the tenant change because of -- they're consolidating their operations or because they want a larger space. In some instances -- there's one of them, because they want to own their own building because they want to perform so many modifications to the building that on the lease facility -- first of all, it may be that we don't allow those drastic changes on the building or it may be that they want to invest such a large amount of money on the building that they -- that is for them is imperative, it makes sense for them to own the facility. But to emphasize, the answer to your question, no, we don't have any pressure from any particular group of investors or any region. It just happened that this year, we had those -- the expiration of those contracts with the situation of the amortization of a build-to-suit that was with a very special investment or above-standard tenant improvements that we did on a building on one of our tenants.

[Yejide Onabule, analyst]

Okay. And then when you think about growth for this business in the next couple of years, if you think about the growth you were expecting pre-COVID and now that we're in COVID, would you say that COVID has had a negative impact on the growth -- the rate of growth that you're expecting to come out of your business? Or how should we think about this?

And then funding, you said that you're going to use part of your AFFO reserves to pay for funding. Would you require any additional funding? There is a 2022 bond. We're just trying to understand. Do you think you will need funding? Would you come to the bond market in 2021?

[Alberto Castillo, executive]

Well, first of all, I will let Carlos answer the question about the situation of the 2022 fund -- of the '22 bond. But let me tell you that, yes, we feel that the growth is going to be basically from the build-to-suits that we -- the pipeline, the original build-to-suits and the expansions. But that will be basically the growth that we have for 2021 at this point.

[Carlos Espinosa, executive]

Yes. On regards of the funding for the bond, as you know, the bond expires in November of 2022. The amount that has to be paid is about USD 89 million. We are expecting to use our revolving credit facility, which today has a USD 300 million capacity, unused capacity to fund this bond. So we are not expecting to issue any additional debt. And for the moment, we are not expecting to issue a new bond.

[Operator]

We have reached the end of the question-and-answer session, and I will now turn the call over to Alberto Chretin for closing remarks.

[Alberto Castillo, executive]

Thank you. Well, thank you all for attending today. I would like to finish the call by thanking everyone in Terrafina for helping us deliver a good year despite the challenging environment we saw globally. We want to continue working with all of our stakeholders to make sure we deliver the best possible results for everyone in 2021. We are also excited to strengthen our ESG strategy this year by launching a building certification program which will help us both better benchmark our portfolio and make sure we are maintaining the building standards our tenants require from us. We look forward to speaking with you all soon again, and thank you for your trust in Terrafina, and have a great day.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.