CI Banco SA Institucion de Banca Multiple FF/00939

BMV:TERRA13

Earnings Call Analysis

Strong Revenue Growth and Margin Expansion in Q2 Earnings Call Summary

During the Q2 earnings call, the company reported a 15% increase in revenue compared to last year, driven by strong performance in all segments. Operating margins also expanded by 3%, reaching 12%. Management highlighted cost-saving initiatives and expects further margin improvements in the upcoming quarters. Guidance was provided for a 10% revenue growth target for the next fiscal year, indicating a positive outlook for investors.

Robust Double-Digit Growth and Expanding Operations

The company reported a notable year with substantial double-digit rent increases across 6.9 million square feet, attributing a portion of this growth to shifts towards higher U.S. CPI adjustments. Adding to their portfolio, new square footage was acquired, intensifying their presence in key markets. This was a response to strong industrial demand, particularly in the Northern and Central regions, bolstering growth opportunities.

Stable Outlook Amid External Challenges

Looking ahead to 2024, management remains optimistic, expecting another solid year supported by growing manufacturing activities and supply chain strengthening. While acknowledging headwinds such as energy access and land development, they anticipate no major disruptions from the upcoming U.S. and Mexico presidential elections.

Active Leasing Cementing Market Position

A total of 7.4 million square feet were leased, including new leases and renewals. The Northern region led with strong occupancy and rental rates due to demand from multinational tenants, whereas the Central region and Bajio also showed robust performance and recovery signs, particularly from the automotive and logistics sectors.

Solid Financial Metrics Reflecting Growth

The year-end revealed a consolidated rental rate increase of 5.8%, with the net asset value per certificate rising by 10.4% year-on-year. Funds from operations (FFO) per certificate and distribution per certificate also respectively saw annual increases of 6% and 6.1%.

Confident Projections and Investor Rewards

Management anticipates maintaining high occupancy rates and retaining tenants, alongside projected same-store net operating income (NOI) growth of 6% to 7%. They also plan to reward investors with an expected annual distribution per share of USD 0.106, affirming their guidance based on historical same-store assumptions.

Enhanced Governance and Financial Outcomes

To unlock further value, the company is considering governance improvements and cost saving measures, projecting $7-8 million in General & Administrative (G&A) expense reduction annually. The implementation of these measures is expected to contribute to higher distributions and a better governance structure.

Revenue and Profitability in Focus

Annual and quarterly rental revenues demonstrated a healthy increase of 10.4%, with NOI and EBITDA margins standing strong. Notably, the FFO and adjusted funds from operations (AFFO) margins reflected a trend of stability and modest growth, reinforcing the company's profitability.

A Strong Balance Sheet to Buttress Operations

The company closed the year with significant cash reserves and a 10.9% increase in investment properties' value. With a total debt of $990.8 million at a moderate cost, and a loan to value (LTV) ratio of 31.7%, the company maintains a healthy and prudent financial position.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning, everyone. My name is Jenny, and I will be your conference operator for today. At this time, I would like to welcome everyone to Terrafina's Fourth Quarter 2023 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, Jenny, and good morning, everyone. Welcome to our fourth quarter 2023 conference call. We are pleased to have with us today from Terrafina, Mr. Alberto Chretin, Chief Executive Officer; and Mr. Carlos Gomez, Chief Financial Officer. Mr. Chretin will take us through the company 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. Any information expressed or implied during 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 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 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, please go ahead.

[Alberto Castillo, executive]

Thank you, Paco. Good morning, everyone, and thank you for joining us today.

We are pleased to be here today sharing the main highlights of our fourth quarter results. 2023 was a good year for Terrafina as we continue to reach important milestones. We had strong organic growth resulting from positive leasing spreads throughout the year. We achieved double-digit rent increases in leases that cover 6.9 million square feet in total. Additionally, we continue to shift our contract rent escalators to higher U.S. CPI adjustments, which helped drive our rates growth further.

New square footage was also added to the portfolio through our sidecar vehicle, increasing our presence in primary markets such as Tijuana, Monterrey and the State of Mexico. Industrial demand was quite strong throughout the year, offering important growth opportunities in the Northern and Central regions.

As the year progressed, we started to see a gradual but steady recovery in the Bajio [ too ] improving our occupancy levels and rental rates. Mexico continues to benefit through new showing trends as multinational tenants work to establish production lines closer to the U.S. market. We expect 2024 will be another solid year supported by growing manufacturing activity and new plans to strengthen supply chains.

Having said that, we are aware of the headwinds that remain present such as access to energy in some markets and the [ lesser ] processes behind getting land ready for development. We also note that in 2024, both Mexico and the U.S. will have presidential elections, but are not expecting any major disruptions in our business since most of our properties are linked to manufacturing activities primarily.

Moving on to our operations and financial highlights for the year. Terrafina was quite active in both renewals and new leasing activity throughout 2023. We signed 1.6 million square feet of new leases, 700,000 square feet of early renewals and 5.1 million square feet of regular renewals. In sum, we signed leases for a total of 7.4 million square feet of GLA. This leasing activity contribute to reaching a new record high occupancy level of 98.1% at the end of the fourth quarter.

The Northern region once again had the most dynamic markets, representing approximately 52% of our leasing activity. Ciudad Juárez, Chihuahua and Ramos Arizpe led the way with an average occupancy rate of 99.7% and an average rental rate of $5.81 per square foot. Most demand came from multinational tenants in the manufacturing for export sector, which has been the case in these markets all year long.

Central region accounted for 25% of our leasing activity, mainly in the Cuautitlán Izcalli, Toluca and Azcapotzalco markets. This maintained an average occupancy rate of 99% and an average rental rate of $6.70 per square foot. An increase in logistics activities has been key for this market's low vacancy levels.

Finally, the Bajio had a better-than-expected performance during the year, representing 23% of our consolidated leasing activity. San Luis Potosi, Guadalajara and Querétaro were the best-performing markets within this region with an average occupancy of 93.9% and an average rental rate of $5.78 per foot. This region continues to show signs of gradual, but steady recovery with the automotive sector showing the most activity in cities such as San Luis Potosi and logistic activity helping Guadalajara and Querétaro. Our effective leasing spreads reached 19.8% with new leases being signed at an average rental rate of $6.52 per square foot.

Our consolidated rental rate by year-end was $5.96 per square foot, a $0.33 or 5.8% increase versus 2022. Terrafina also added a total of 3.3 million square feet of new GLA during the year. These included developments, expansions and M&As, which for the latter were closed through our sidecar vehicle. Overall, these properties added a total of $6.3 million to our annual NOI. Our net asset value per certificate increased 10.4% year-on-year as the appraised value of our existing portfolio continue to reflect positive demand supply dynamics in this sector.

Our FFO per certificate for the fourth quarter in dollars saw a 6% year-on-year increase because of our organic growth and the contribution from properties added throughout the year. And finally, our distribution per certificate for the year saw a 6.1% year-on-year growth, having distributed a total of $77.2 million or USD 0.10 per certificate. As for our sustainability effort, we continue to focus on the execution of our ESG strategy.

In 2023, we added 2.6 million square feet of new green certifications to the portfolio including both operational certification and property certification. We also strengthened our commitment to continue to provide key information in our 2023 integrated report as well as our active participation in the global standards, such as the Standard & Poor's Global Corporate Sustainability Assessment Questionnaire, reaching a high score that led to the inclusion in the 2024 Sustainability Yearbook. This recognition aims to distinguish individual companies within their industries that have demonstrated strength in corporate sustainability and only 8% of the 9,400 companies assessed are included in the sustainability yearbook.

2024 outlook and guidance. Now let me share with you our view for 2024 and key information on our guidance for this year. First, we remain confident that Mexico will continue to be a preferred industrial destination for international companies establishing operations to tap into the U.S. market. This should support demand in the industry even further. 18% of our total GLA or 7.2 million square feet will roll over in 2024. 56% is concentrated in other regions, mainly in Chihuahua, Ciudad Juárez and Ramos Arizpe. 21% is in the Central region, mainly in Cuautitlán and Toluca. 23% is in the Bajio concentrated in Querétaro, Guadalajara and San Luis Potosi. Overall, we do not expect a significant number of terminations as most of our renewals will take place in markets with high occupancy levels where there is a lack of supply.

As a result, we expect a high occupancy rate by the end of 2024 between 97.5% and 98.5% and a retention rate in the mid-80s to the low 90s. We expect same-store NOI growth of 6% to 7% and are forecasting an annual maintenance CapEx of USD 0.26 to USD 0.28 per square foot of our total GLA.

Finally, for our annual distribution per share, we expect to pay out USD 0.106 and it's important to mention that our guidance is based on the same-store assumptions as always. I want to comment on the recent recommendation made by our Technical Committee in January to internalize our advisory functions.

At Terrafina, we continuously look for the best alternatives for all our stakeholders. We diligently analyze and execute different strategic plans in line with what we see is best in the market. We strongly believe that internalizing the adviser is in our best interest. This change will be in line with global best standards, generating a better alignment with investors' interest under an improved governance structure. As we announced in the third quarter conference call last year, Practices Committee initiated a complete evaluation of the benefits of an internalization of the external adviser services provided by PGIM real estate.

After 3 months of hard work with specialized consultants, the Practices Committee recommended set internalization to the Technical Committee. And after analyzing their findings, the Technical Committee voted in favor of this recommendation. This modification will be discussed and subjected to a vote in an extraordinary shareholder meeting soon.

In preparation for this, we have made major progress in the business plan under the internalization scenario. We intend to be ready for this transition so that if the internalization is approved, there will be no disruption in our day-to-day operations. Our long-standing property management partners have reiterated their continued support should we change our structure, and we have identified the key positions within Terrafina's organizational structure that will need to be created.

With this, the team at Terrafina will be prepared to absorb all functions and immediately generate savings that could lower our G&A expenses by an estimated $7 million to $8 million per year. And this will, in turn, increase our possibilities for higher distributions. We believe that the combination of a better governance structure and cost savings will unlock the value we see in our certificates, which as of today trade at a 9% discount to NAV.

Furthermore, we believe that as an internalized company, we can improve our growth outlook by increasing our access to capital markets and offering the benefits of scale that an internalized structure can supply. We are planning to increase the number of independent members in our Technical Committee to further diversify their areas of expertise and strengthen the execution of our various operational and ESG goals.

We believe this new path represents a great opportunity to stand out as the leading Mexican industrial REIT with a best-in-class internalized structure. We want to be the best investment alternative to get exposure to manufacturing-for-export activities with a steady dollarized cash flow and promising growth in primary markets. Moreover, we recently mentioned in our press release issued on February 13, the Technical Committee of Terrafina continues to work on the analysis of various strategic alternatives aside from the nonbinding expression of interest received from FIBRA Prologis.

It is important to mention that we will keep you appropriately informed and will stand ready to do what is required if any alternatives materialize as Terrafina continues diligently acting in the best interest of our certificate holders.

And before I pass the call to Carlos, I would like to mention that currency translation adjustments caused by the peso appreciation in 2023 on our dollar-denominated debt led to a positive tax income result. Because of it, Terrafina will make an extraordinary cash distribution that will be subject to taxation. This extraordinary distribution will be of $69.4 million or MXN 1.2 billion and will be funded with our revolving credit facility, which as of today, has a total availability of $198 million. Having that Securities payment, Terrafina's total loan-to-value will be in the 33.9% range. We expect to pay partially this debt back with cash resources from the disposition activities that were executed in the first month of this quarter.

Thank you for your time. And now I will pass the call to Carlos. 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 noncash items as well as nonrecurring and transaction-related expenses, the latter of which are only included in the AFFO. To start, our annual and quarterly rental revenues reached $216.5 million and $55.6 million, respectively, which implies a 10.4% year-on-year increase.

NOI was $201.7 million, of which $51.7 million came from the fourth quarter, a 6.9% year-on-year increase. That implies a 93.2% NOI margin. Full year EBITDA totaled $176.4 million, of which $44.9 million were generated in the fourth quarter, demonstrated a 6.2% increase and an 81.5% margin.

Our FFO reached a total of $127.2 million, of which $32.2 million were generated in the fourth quarter, a 3% increase and a 58.8% FFO margin. AFFO per certificate was USD 16.49 per certificate, a 3% increase compared to 2022.

Finally, 2023, AFFO reached a total of $107.4 million with $26.8 million from the fourth quarter, a 2.8% year-on-year increase. Our distributions for this year were $77.2 million or USD 0.10 per certificate and our distributions for the fourth quarter were $19.3 million or USD 0.025 per certificate.

Moving on to our balance sheet. We closed the quarter with $37.6 million in cash. Our investment properties closed the year at $3 billion, a 10.9% year-on-year increase as the appraisal value continues to increase under a solid industrial real estate market. Our total debt at the end of 2023 closed at $990.8 million with an average cost of debt of 5.61% and our average weighted maturity of debt was 4 years. Finally, our LTV reached 31.7% 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]

Your first question is coming from Hugo Grassi of Citibank.

[Hugo Grassi B. Soares, analyst]

Congratulations on the quarter. Can you hear me?

[Operator]

Yes.

[Hugo Grassi B. Soares, analyst]

Gentlemen, congratulations on the quarterly results. Thank you for the opportunity to ask questions. I'd like to ask about the -- can you hear me?

[Operator]

I think line has just dropped, everybody. So apologies for that. I'm hoping that Hugo can jump back into the queue once he dials back in. I will take another go at the questions.

[Operator Instructions]

Not seeing any questions come into the queue just this moment, we do have one. Okay, we have a question coming from Francisco Chavez of BBVA.

[Francisco Chávez Martínez, analyst]

My question is regarding the potential internalization in case that the CBFI holders approved and how fast can you implement the internalization.

[Alberto Castillo, executive]

Thank you, Pat, for the question. Yes, we have been going into a lot of detail about the activities that will take place for the transition of the management of the company if the transaction is approved. To answer your question, we have -- first, we have 3 months before it's been announced until it's actually secured. And we think that we'll be ready to take over the manage -- the total management after that 3-month period. In addition to that, we have also started already to put more details into our business plan, which is the internalized company.

We have identified a lot of the positions that will be added to Terrafina as well as the activities that will have to take place with the property managers as well as the functions that will need to be replaced from once we start the internalization. So to answer your question, the 3 months will be sufficient, okay, to do that. But we are not waiting for that. We just already started to assess all the different activities that will take place and also to perform all of the activities that had to do with the organizational chart and the list of information that we will need from PGIM to execute this.

[Francisco Chávez Martínez, analyst]

Okay. And just another question, if I may, and that's regarding the strategic alternatives that you are currently analyzing on the nonbinding tender offer that you received from FIBRA Prologis. Is there a deadline for your analysis?

[Alberto Castillo, executive]

No, no deadline.

[Operator]

Your next question is coming from Juan Macedo of GBM.

[Juan Pablo Macedo Carrillo, analyst]

I'm sorry if already answered, I had some issues connecting. We saw some delays on project deliveries expected for this Q. So we were wondering if you could give us some detail on these delays. And additionally, if you could give us some color on what trends do you see in general in industrial developments?

[Alberto Castillo, executive]

Can you specify the delay of what. Can you specify that question about the delay on what?

[Juan Pablo Macedo Carrillo, analyst]

Yes. We saw delays on 3 development projects that were -- 2 development projects that were penciled to be delivered in the fourth quarter, they were pushed back, I think, to the third quarter of 2024.

[Alberto Castillo, executive]

No. Those developments were not delayed. I think that they are in time in terms of the -- when they are going to be finished and then the expected time to be producing NOI. That's what you see on the -- for the third quarter for 2024. So since 2 of those are -- have some tenants already, but that also depends on the commitment made to the tenant. So they are not delayed. They are very much scheduled based on the pace of the construction and when they're going to be leased.

[Juan Pablo Macedo Carrillo, analyst]

That makes sense. And just one additional question regarding the potential offers you received. You obviously have received the FIBRA Prologis one, but we were wondering if you could give us some detail into what other kind of offers are you receiving? Are there more acquisition offers, maybe joint ventures of something of the style. We understand if you can -- but if you could give us the details, it would be great.

[Alberto Castillo, executive]

Well, we are -- as I said before, we analyzed several strategic initiatives. And before we go to the shareholders assembly to ask for the approval of the internalization. We want to make sure that all of the available and relevant information is presented to the shareholders before they made that decision, and we will do so.

[Operator]

Your next question is coming from Hugo Grassi. He's back from Citi.

[Hugo Grassi B. Soares, analyst]

Hi, gentlemen, I do apologize for the connectivity issue earlier. My question is on the internalization of advisory services. And I'd like to ask you to comment on both timing, scope and perceived risks. And by timing, I mean, while you mentioned that you have an incoming general -- extraordinary general assembly on its way, how long do you think it should last? And once it's approved, is it reasonable to expect a perhaps 6-month window until full implementation? That's for timing. As for scope, you mentioned a 7 million to 8 million G&A savings on the internalization process. What does that refer to as far as a range of services that should be internalized, leasing, capital markets, legal, ESG, what's the scope of internalization.

And as for perceived risks, what do you understand as perhaps a disruption risk that could happen as you change teams from hands to hands. Is there anything that you're particularly concerned about? So if you could comment a little bit more on, again, timing, scope and risks, I'd appreciate.

[Alberto Castillo, executive]

Certainly. Thank you very much, Hugo. As far as I mentioned before, once the internalization is approved and once PGIM is notified, we have 3 months to fully proceed with the internalization. And we already made an assessment of that, if we can, and we will, if it is approved, totally internalize the company within that 3-month range. That's as far as timing. As far as the scope, we have identified with a lot of precision all the activities that PGIM is doing for Terrafina. And we have also a specific action plan for each one of those activities and I'd like to remind everybody that PGIM has a lot of outsourcing of the functions that are being performed for Terrafina, including property management, accounting, tax, and in other development supervision activities. So we have identified all of those.

We have had conversations also with all of our property managers who are the ones that having -- are in contact with our tenants, many of whom I personally know and we know them for 10 years. You remember that we've been working with them for 10 years together. And we have, as I mentioned, we have -- so the scope of the internalization is going to be total. We will perform all of the functions that currently PGIM is performing right now, including the ones that you mentioned. That's capital markets, property manager supervision, compliance in general, all of the functions.

In terms of the risk, of course, we do have a very detailed program about what is going to be taking place. And we are also working with some consultants some assistance also with some advisers to make sure that we identify all those risks, and we have actions to mitigate the risk or to totally eliminate that risk. We know the tenants. We know the markets, the contacts that we have with the property managers, we even have a relationship with the market officers from the property managers. So the risks have been assessed, have been identified. And also, we have a plan to mitigate all those risks.

[Operator]

Your next question is coming from Pablo Monsivais of Barclays.

[Pablo Monsivais, analyst]

I have actually two questions that are related. What -- in the case you internalize, what will be the future for the sidecar facility. I don't know if there are some covenants attached to it. And the second question is, assuming that you internalize. What strategic plans, what do you have envisioned for Terrafina going forward? Are you going to focus on M&A? Or are you going to plan to develop instead? What should investors expect once you execute that plan.

[Alberto Castillo, executive]

Thank you for the question, Pablo. Well, let me go first with the first one. The sidecar, if you remember, is a joint venture between a U.S. pension fund and Terrafina and PGIM is the manager of that joint venture. Even with the internalized Terrafina, the sidecar is going to continue exactly as it is operating now because PGIM is managing the sidecar the same way that they manage the [indiscernible] and other investment vehicles that they have. So the sidecar can coexist with the internalized Terrafina exactly as it is now.

Having said that, the fact, as you know, that the PGIM real estate is the one that brought the partner, and they work very much in conjunction with us to sell with that joint venture. And I can say that the joint venture continues to work very well. And as far as we are concerned, the sidecar can continue to operate exactly the way it is. And as I mentioned before, the sidecar coexists perfectly with the internalized Terrafina.

And we said that, we do if the partner doesn't feel comfortable with this new scenario, they can -- we can have conversations towards continue or to trigger some buy-sell opportunities or basically continue the way it is. I just want to point out that if the interest takes place, it may be a small change in the way we establish [indiscernible] worlds between what is happening with the sidecar and the activities of Terrafina. But as I say, we can co-exist very well. And it's going to depend on our partner to see if we want to continue the way that we are or we pursue a different [indiscernible].

In terms of the plan, thank you for the question, but we do have a very detailed strategic plan for internalized Terrafina. This includes how much we're going to be growing the company by means of development, which we are going to increase development and how much we're going to increase in terms of acquisitions we have identified. We're hoping that with and when we are internalized, we're going to be able to tap the market to reduce the discount to NAV of our certificate, talk to the markets and get funds to continue with the growth that we had at the first 5 years of the company and with more emphasis on development and then this detailed plan that I mentioned also addresses the markets in which we're going to accelerate our presence which markets we're going to continue to develop.

And if any, if we want to reduce our exposure in some markets in order to take advantage of the growth of normal markets. So we do have and continue to work on a very ambitious, but again, realistic strategic plan for the company as an internalized vehicle in which we're not going to internalize the company, as I mentioned before, but the new organizational chart reflects an approach of a real estate company instead of a global investment management of an external company and we will share that with you in time about this ambitious plan that we have for the internalized company.

[Operator]

Your next question is coming from Lucila Gomez of the Compass Group.

[Lucila Gomez Palomino, analyst]

It's just a follow-on on the JV sidecar question. I understand that you guys have already deployed around 70% of the resources. I'm just wondering if things continue as they are, should we maybe expect for you guys to deploy the rest of the 30% this year? Or do you think it's going to be more gradually?

[Alberto Castillo, executive]

Thank you, Lucila. No, absolutely. We think that we're going to deploy the 30% balance of the capital allocation for the JV and indeed, we expect that to happen this year, and I expect that to do that even sooner than later. So the JV continues to operate, as I mentioned before, even after the announcement of the internalization to our partner, we executed an additional investment that we had planned. So we don't have any indication that we're not going to continue with the deployment of this, of the 30%, and it will happen this year.

[Operator]

[Operator Instructions]

We don't appear to have any further questions in the queue. I'll now hand back over to the management team for any closing comments.

[Alberto Castillo, executive]

Thank you, Jenny, and thank you all for attending today's call. I would like to thank you for your trust in Terrafina. We are very excited about this new phase and are convinced its evolution will lead to value creation for all of our stakeholders. We look forward to sharing this with you. Have a great day.

[Operator]

Thank you very much, and thank you very much to everyone. This does conclude today's conference. You may disconnect your phone lines, and have a wonderful day and a wonderful weekend. Thank you for your participation.