CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Transcript 2022-Q4

[Operator]

Good morning. My name is Ali, 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]

Thank you for your attention. And I will now turn the call over to Francisco Martinez, Terrafina's Investor Relations Officer. Please go ahead.

[Francisco Martinez, executive]

Thank you very much, Ali. And good morning, everyone. Welcome to our Fourth Quarter 2022 Conference Call. We're pleased to have with us today from Terrafina, Mr. Alberto Chretin, Chief Executive Officer; and Mr. Carlos Gomez, Chief Financial Officer. And Mr. Chretin will take us through the company overview and operations, and Mr. Gomez will discuss on the financials.

So before we begin, we would just like to refer you to the note on forward-looking statements in our quarterly report for 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, anticipating 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, 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. Good morning, everyone, and thank you for joining us today. I am pleased to be here sharing our fourth quarter results with you. 2022 was another strong year for Terrafina, a year in which we reached many positive milestones, including the completion of our 3-year growth plan ahead of schedule. This was supported by a solid dynamic in the industrial real estate sector in Mexico, where demand for industrial space continues to drive growth.

As you saw throughout the year, at Terrafina, we grew our presence in selected strategic markets, especially in the northern region, where we have a relevant share of our portfolio. This includes Ciudad Juárez, Tijuana, Nuevo Leon and Coahuila. Our key performance indicators closed at a high note as Mexico continues to benefit from new showing activities. This supports our activity with both existing tenants that need to relocate operations and new tenants that see a remarkable opportunity to establish production lines closer to the U.S. market.

We expect 2023 will still be supported by additional investments in supply chain ecosystems due to growing manufacturing activity. This is particularly visible in the automotive and electronics industries, especially in electric vehicles and semiconductors. We are already seeing some R&D activities in Mexico as well as plans to have back-end assembly, testing and packaging in the near future. If geopolitical tensions increased, there is a good chance they will accelerate multinational tenants plans to open new production facilities outside of Asia.

Moving on to our highlights for the year. Let me start with our growth strategy. Terrafina added 900,000 square feet of GLA from properties developed in Ciudad Juárez, Tijuana and Apodaca during the year. During 2022, our development activity covered 90% of our 3-year goal. We expect to conclude our pending commitments during 2023 and to generate $8.8 million of NOI during the year as part of the 3-year growth plan.

As we recently announced, seeing that we were about to conclude this strategic growth plan, we wanted to define our next steps for the coming years. With the cost and support and expertise of our partner, PGIM Real Estate, we work on structuring a new vehicle that will give us access to additional firepower to increase our growth plans in core markets. Under this new cycle, we will have partnership with an international pension fund and we'll have access to a total of $400 million, which we estimate are equivalent to adding 5 million square of GLA to our portfolio. This vehicle will be focused on acquisition, development, leasing and management of industrial real estate assets located in strategic markets such as Tijuana, Ciudad Juárez, Monterrey and the State of Mexico.

This structure will not dilute our current investors as we will use our own AFFO reserve to fund it. We will also maintain our LTV level at or below 35% in line with our internal leverage policy. We estimate the cycle will start deploying resources this year to fully commit $400 million over the next 2 or 3 years. It is also worth noting that as part of this structure, Terrafina has a right of first offer clause in which we have the option to buy our partner's stake at fair market value [ at the ] year price.

We are very excited about this new vehicle as it represents an opportunity to further strengthen Terrafina's position as a relevant player in the consolidation of industrial real estate space. It is also a great alternate to take advantage of current nearshoring trends without diluting our existing shareholders.

Moving on to our leasing activity. Throughout 2022, Terrafina was quite active. With the hard work and commitment of our property managers, we signed 2.6 million square feet of new leases, 1.3 million square feet of early renewals and 3.5 million square feet of regular renewals. In total, we signed leases cover 7.4 million square feet of GLA. The northern region was again the more dynamic representing approximately 72% of our leasing activity. Ciudad Juárez, Chihuahua, Ramos Arizpe and Tijuana led the way with an average occupancy rate of 99% and an average rental rate of $5.80 per square foot per year. The main driver in this market was manufacturing activity, which encourage multinational tenants to renew or increase their operations there. We expect this trend to continue during 2023.

Moving up, 14% of our leasing activity was concentrated in the central region led by the Cuautitlan Izcalli, Huehuetoca and Toluca. These markets had an average occupancy rate of 97% and an average rental rate of $6.20 per square foot per year in quality plant in Toluca, and $4.85 per square foot per year in Huehuetoca. The logistics sector keeps playing an important role in the central region. We continue to see high demand for these tenants as well as an above-average renewal rate. This had led to a low vacancy levels.

Finally, the Bajio represented the remaining 14% of our overall leasing activity. San Luis Potosi, Guadalajara and Queretaro were the best-performing markets within this region with an average occupancy of 92% and an average rental rate of $5.60 per square foot per year. This region continues to show a gradual comeback as the automotive sector recovers in markets license like San Luis Potosi, and the strong leasing and manufacturing activities continues in Guadalajara and Queretaro. As a result of all of this, our occupancy rate closed at 96.4% for 2022 and our renewal rate for the quarter was 99.1%.

In the last quarter of the year, we also had a double-digit leasing spread of 22.8% as leasing contracts closed at an average rental rate of $6.47 per square foot per year. Our consolidated rental rate for the year was $5.63 per square foot per year and a 4.3% increase or $0.23 higher compared to 2021. Our net asset value per certificate increased 20% year-on-year, reflecting a positive demand supply dynamic in the industrial real estate space.

Before I move on to 2023's outlook and guidance, let me mention some highlights from our ESG efforts. As we evolve in the execution of our strategy, Terrafina continues to be recognized as an important sustainability player, adapting policies and guidelines to optimize its contribution to environmental governance and social topics. In 2022, we were able to maintain our CSA score among the 3 top [ pivots ]. We were also included in the S&P Total Mexico ESG Index. Terrafina continued with its sustainability certification process for new GLA added to the portfolio, and we expect to have even better results for this in 2023. We improved our data collection across our portfolio to generate accurate information to measure our key performance indicators.

And finally, we also launched efforts to update our materials analysis, which will be a key catalyst to maintain our commitment to [ sustainability ] going forward. We are convinced it makes our organization more resilient and prepared for the future.

Moving on to our guidance for 2023. Let me just say that we are as confident as ever about this year's outlook given the strong momentum we continue to see in the industrial real estate sector. Demand for new space is still strong. And leasing activity in core markets, especially in the northern region, where Terrafina has a leading position, remains solid. We expect to see high occupancy levels and healthy rent increases. We should favor our cash flow generation.

As vacancy rates remain at record lows in core markets like Tijuana and Ciudad Juarez, growth opportunities will still exist we can say with great confidence that [ maturing ] activities we've gained pace. We do recognize, however, that access to reliable energy sources for new developments can be difficult at times. This is part of why Terrafina will dedicate 85% of the sidecar resources to the acquisition of stabilized portfolios.

As for our lease expiration schedule for the year, we are expecting to lease 6.2 million square feet of GLA to maturity. This implies 16% of our total GLA to roll over, 62% of this is concentrated in the Ciudad Juarez Chihuahua and Ramos Arizpe markets; 21% in the central region, mainly in Cuautitlan and Toluca; and 17% in Bajio, concentrating San Luis Potosi, Guadalajara and Queretaro. We are comfortable with this given the overall market dynamics, and thus, we expect to see an occupancy rate for 2023 between 96.5% and 97.5%. The average renewal rate for the year is expected to be in the mid to high 80%.

Rental rates are expected to keep rising the positive trend we saw during 2022, and our annual NOI in the $198 million to $200 million average range. We forecast an annual maintenance CapEx of USD 31 to USD 35 per square foot of GLA. And finally, our annual distribution per share, we expect to pay for the year.

Thank you for your time. And now I will pass the call to Carlos. 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 non-cash items as well as nonrecurring and transaction-related expenses, the latter of which are only included in the AFFO.

To start, net connections in 2022 reached $197.5 million, a 4.2% increase compared to 2021. Our annual and quarterly rental revenues reached $196 million and $80.7 million, respectively, which implies a 4.6% year-on-year increase. NOI was $188.6 million, of which $48 million came from the fourth quarter, a 3.6% year-on-year increase that implies a 93.6% NOI margin. Full year EBITDA totaled $166.1 million, of which $41.9 million were generated in the fourth quarter, demonstrating a 3% increase and an 82.4% margin.

On our FFO, we reached a total of $123.5 million, of which $30.4 million were generated in the fourth quarter, a 2.9% increase and a 61.3% FFO margin. AFFO per certificate was USD $0.1598 per certificate, a 4.4% increase compared to 2021. Finally, 2022 AFFO reached a total of $104.4 million with $23.4 million coming from the fourth quarter, a 2% year-on-year increase. Our distribution for the year were $73.1 million or USD [indiscernible] per certificate. And our distribution for the fourth quarter were $16.4 million, which is at USD 0.212 per certificate.

Moving on to our balance sheet. We closed the quarter with $37.9 million in cash. Our investment properties closed the year at $2.7 billion, a 10% year-on-year increase as the appraisal volumes continue to grow under a solid industrial real estate market. Our total debt at the end of 2022 closed at $888.5 million, with an average cost of debt of 5.2%, and our average weighted maturity of debt was 5 years. Finally, our LTV reached 32.9%, in line with our guidance of 35%.

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 is coming from Carlos Peyrelongue with Bank of America.

[Carlos Peyrelongue, analyst]

Two questions if I may. With regards to expected positive lease spreads, I mean you mentioned that you have a record high occupancy vacancy is at record lows, obviously. What can you expect for contracts that are expiring in terms of rents? We understand that we're seeing double-digit increases in rents. If you could comment on the expected positive lease spreads, that would be helpful. That would be the first one.

And the second on the sidecar JV that you mentioned, what type of incremental growth can we expect for TERRA from this JV. If you could give us any color, that would be helpful as well.

[Alberto Castillo, executive]

Thank you, Carlos. Thank you, Carlos, for your questions. On the first question, yes, we had, as I mentioned before, a 22% lease spread on the renewals for the fourth quarter. This was the result of a very successful negotiations with our tenants. And the acknowledgment also from the -- from the tenants that the rental markets, the rents that in the market which we operate has increased. So we expect during 2023 to have similar rent growth throughout the year for the negotiations of the contracts that expired during 2023. So to be precise with your question, we do [ anticipate ] in double digits, and it can be all the way to the 20% again.

And in terms of the second question, the sidecar, as we mentioned, we will fully deploy the joint venture. We're going to have $500 million or $400 million, and this is going to mean about 5 million square feet of additional GLA to our portfolio. We expect that this $400 million will be deployed during the first 2 or 3 years of this joint venture, and we already have a robust pipeline of business.

Let me put it this because it's going to be some acquisitions that are in the pipeline as well as development of our land, which is in some of the primary markets in which we operate. So this -- in this initial growth, and I call it initial because we are very confident that these new sidecar scenario will not only be successful in the first phase, but we think it's going to be another opportunity to continue to provide growth for Terrafina without diluting our current investors.

[Operator]

Our next question is coming from Juan Ponce with Bradesco BBI.

[Juan Ponce, analyst]

I have 2 if I may. The first one is on tenant improvements. We saw that it weighed a little bit on the AFFO this quarter. So how should we think about this line in 2023?

And my second question is on the sidecar. It's more strategic. What is the rationale behind deploying most of the proceeds to acquisitions? I understand they're stabilized. But when development spreads look more attractive?

[Alberto Castillo, executive]

Well, let me take your second question, Juan. And I'll ask Carlos to answer the first question. The rationale for the sidecar to deploy most of the resources on development -- on acquisitions, I mean on acquisitions, is because right now, the environment for development is having -- is facing some headwinds instead of the supply of infrastructure, specifically electricity. So even that we have some good tracks of land and there are -- as you mentioned, as I'm sure you know, the development yields are better than the cap rate for acquisition. There are some complexities on in terms of development because of the reasons that I just mentioned.

So that's why we also see that there are, in the market, some good stabilized portfolios. And in order to accelerate the velocity of growth, we are assigning about 85% of the resources of the sidecar to acquisitions. We are confident that there are several opportunities for acquisition of portfolios that are in the markets we want to grow as well as the characteristics of the -- of those portfolios, including the quality of the tenants. And that's why we're focusing on that 85%.

Having said that, the other 15% also, we -- of course, we will capture the developing yields and the opportunities to add new tenants to this -- to Terrafina as well as some expansions that we may do in land that is adjacent to our current facilities with our tenants. And Carlos, can you comment on the first question on TIs for Juan, please?

[Carlos Espinosa, executive]

Yes, Alberto. On regards of the TI for the fourth quarter of the year, we were catching up since in the -- especially in the first 2 quarters of the year, we were unable to deploy the amount for all the expenses that we had to do mainly because of the disruption in the supply chain, but the final number of 2022 was within our budget. So we are fine with that. In regard of 2023, we are expecting to spend between USD 0.30 and USD 0.33 per square foot, which is roughly the same budget that we had for 2022. We are targeting to do it in a more smooth way quarter-by-quarter, but we depend on market conditions for that.

[Operator]

Our next question is coming from Pablo Monsivais with Barclays. .

[Pablo Monsivais, analyst]

Just a quick one. Right now, for the 16% of the portfolio that is expiring next year, what is the in-place rents relative to the market rent? And on your overall portfolio, how much is the increased rates right now relative to market?

[Alberto Castillo, executive]

Well, thank you for your question, Pablo. Yes, for the 16% of the portfolio that is going to roll over 2023, we expect to have double-digit rent growth. So we were very successful in renewing the expirations in the fourth quarter of last year, as I mentioned 22%. So the negotiations for 2023, I see that's going to result in rent growth for those contracts that roll over of between 10% and 20%.

[Operator]

Our next question is coming from Andre Mazini with Citigroup.

[André Mazini, analyst]

So my question is on EVs, right? So you mentioned in the MD&A that you guys are looking closely to the EV manufacturers moves. And of course, you've seen a lot of news on Tesla. They're deciding which part of the country they're going to go to. There are some water issues for some of the regions, right? So that's been taken into consideration, both among that manufacturers' part and also even in the politicians and the government's part, right? So where do you see the most promising land -- pieces of land or regions for the EV manufacturers to be located, given the water considerations? And how much can that move the needle really in terms of lease up, do you think? And if it makes sense to preemptively look at this where these guys are going to be located, sourced, land over there to cater to this new ecosystem that the EVs manufacturers seem to be setting up in Mexico.

[Alberto Castillo, executive]

Thank you, Andre. I think that this is a very interesting question. It's very -- the timing is very good. Well, let me just try to answer this from the perspective of our tenants. As you know, over 30% of our manufacturing tenants are in the auto sector, and we have visited a lot of our tenants in the auto sector to gauge how much they were involved in the EVs and as well as the hybrid and even some hydrogen fuel automotives. And we were very pleased to see that 50% -- I think about 50% of our tenants are already participated in the EV or hybrid systems car industry. We think that the electric vehicles is going to continue to penetrate faster than it was anticipated, and we are very pleased to see that the -- our tenants are participating already on the important plans for the operators to participate on the EVs.

In terms of your question about the locations, of course, the northern region is more natural for any assembly plant or OEM who plans to build automotive cars, and especially the EVs. And the water issue is not -- and I don't want to see more controversy, but the water is not a substantial issue to limit the investment. There are other factors that are certainly much more important to take into consideration when it comes to location of an OEM plant. And I'm sure that the decision to establish the Tesla plant will have to do with all the competitive -- and the [ competitive ] and the absolute advantages of different regions. In -- but regardless of where it is, in my opinion, I think it's going to have to be in the north because the OEM companies, they look for capabilities, not only infrastructure, but also talent as well as logistics and [ majority ] that influence their decision.

So -- but taking into account those possibilities, we are well-positioned in the automotive sector, both in the north and in the Bajio. And I think that we do not -- we are not going to anticipate any investment in view of what the decision may be. But certainly, we're monitoring that very closely. And that tenants are also, I think, they're very well-positioned to capture the opportunities that this new Tesla investment will -- when that materializes, wherever it materializes. I know it's not a very definite answer. But again, we -- regardless of where it's going to locate, I think that the important point for us is that it does -- that Tesla does [ start it's ] operation in Mexico.

[Operator]

[Operator Instructions] Our next question is coming from Juan Macedo with GBM.

[Unknown Analyst]

My question is regarding the sidecar investment vehicle. You said that you would use your AFFO resources to invest in this vehicle. I was wondering if you have plan to contribute any land into the $400 million?

[Alberto Castillo, executive]

Yes. Thank you, Juan. Yes, part of the joint venture contributions from the Terrafina is going to be land. The 15% of the [ resource ] that we're going to develop through the joint venture, we're going to have that contribution through land to the joint venture at current value, at market value. And we will add -- we will contribute part of the $100 million that Terrafina wants to contribute is going to be by means of land at market value.

[Unknown Analyst]

Great. And just one more question. We obviously see the effect that the nearshoring had on the northern region. And we personally see that the Bajio region has some potential, too. We were wondering how you were seeing the Bajio region trends in this regard.

[Alberto Castillo, executive]

Yes. Thank you for the question, Juan. Yes, the Bajio indeed, has -- it's been recovering slowly. But surely, it's been recovering. And we do make an assessment of the opportunities in the Bajio, and we are adding another property manager to Bajio who specializes in automotive industry to capture this opportunity. To answer your question, yes, we are reacting to the additional possibilities of the Bajio due to the increase in activity in the auto sector, especially with the approach of EV vehicles.

[Unknown Analyst]

Congrats on the results.

[Operator]

As we have no further questions in queue, I will hand it back to Mr. Chretin for closing comments.

[Alberto Castillo, executive]

Thank you. Well, and thank you all for attending today. I would like to [ release ] the call by thanking everyone in Terrafina as well as in PGIM Real Estate and partners for your helping commitment. This has been a key element for Terrafina to be able to deliver solid results again. I would also like to thank our stakeholders for their continued trust and reiterate how fundamental they are to our growth. We remain available for further questions via e-mail and telephone. Thank you all for your time, and have a great day.

[Operator]

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