Corporacion Inmobiliaria Vesta SAB de CV

BMV:VESTA

Earnings Call Transcript 2018-Q3

[Operator]

Good morning. My name is Doug, and I'll be your conference operator today. At this time, I would like to welcome everyone to Vesta's Third Quarter 2018 Earnings Conference Call. [Operator Instructions] And as a reminder, this call is being recorded. I would now like to turn the call over to your host, Ms. Christianne Ibañez, Vesta's Investor Relations Officer. Please go ahead.

[Christianne Ibañez, executive]

Thank you for joining our call to discuss our financial results for the third quarter of 2018. With us today from Vesta in Mexico City are Lorenzo Berho Carranza, Chief Executive Officer; and Juan Sottil, Chief Financial Officer. Following the prepared remarks, there will be a question-and-answer session during which time, we will answer your questions. Yesterday, we issued our earnings press release after market close. The release is also available within the Investors section of Vesta's IR website.

Before turning the call over to management, I'd like to remind you that this conference call includes forward-looking statements based on currently available information. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from those predicted in such forward-looking statements. Statements made on this conference call should be considered together with cautionary statements and other information contained within the company's earnings release dated October 25, 2018, and within the most recent regulatory filings for discussion of those risks. All figures included herein were prepared in accordance with IFRS and are stated in nominal U.S. dollars unless otherwise noted.

Let me turn the call over to Mr. Berho. Please go ahead.

[Lorenzo Dominique Berho Carranza, executive]

Thank you, Christianne, and thank you, everyone, for joining our earnings call today.

As you know, I've been leading Vesta for almost 3 months now, and have an extensive tenure at the company in different operational roles. As I noted when I assumed the role of CEO I'm committed to further strengthening Vesta's market position and achieving higher levels of growth.

This won't be without its challenges as we're operating in continually shifting political, economic, technological and social environments. However, as our performance over the last 6 years has demonstrated, we have more than doubled the size of our company. That's a fact important for competitive advantages. We are the undisputed leader in industrial real estate in Mexico, with a portfolio of clients from a diverse range of countries and industries.

What's more, our vertically integrated management are considered to be locals with offices in each geography in which we have a presence, a unique competitive advantage. Proximity to our clients enables us to maintain our close relationship while gaining superior market intelligence and visibility that allows us to anticipate shifts in our markets and make the right investment decisions.

And I'm happy to report that we're confident about the growth opportunities we're seeing even beyond 2020.

Moving forward, we plan to leverage our past success with a renewed focus on total shareholder return. Leaders of value per share growth and sound periodic dividends guided by the Vesta-Vision 2020 strategic plan, the focus of which is developing and optimizing our growing property portfolio.

We will remain close to existing markets while assessing new markets with similar profits and return profiles.

Evidencing the effectiveness of our strategic plan, Vesta's NAV per share finished the third quarter at $2.09, a 7.7% increase over last year's comparable quarter, results that reflect our strong operating and financial performance.

Revenue grew just over 20% during the quarter while net operating income increased nearly 21%. We now expect year-end revenue growth to exceed the upper range of our full year guidance of 20%.

We also expect to exceed our 2018 margin guidance for NOI and EBITDA, which was 95% and 83%, respectively

as we continue to leverage back to scale. Our strong performance was also a result of achieving a record 98% occupancy rate in Vesta's same-store portfolio during the quarter.

Our newly appointed Chief Commercial and portfolio officers are successfully caring out their new roles, securing new leases at a fast pace as well as efficiently managing our growing property portfolio.

All while maintaining our characteristic discipline, to emphasize accretive long-term leases with high-quality tenants.

During the quarter we leased 1.1 million square feet, driving stabilized occupancy to nearly 97% while also adding just over 400,000 square feet of GLA to our total portfolio of 180 high-quality industrial properties with a combined GLA of nearly 29 million square feet and with a balanced industry exposure that diversifies risk.

To share with you some insights on what we're currently seeing in the market, the conclusion of Mexico selections, and of the final chapters of the new trade agreements USMCA this past summer have renewed confidence in Mexico and North America altogether as diverse premier manufacturing and logistics hub.

This new visibility has resulted in increased demand with an even stronger pipeline as of today. We note strong demand by existing tenants who need to expand with increasing risk by global producers who recognize Mexico with our ability as a manufacturing hub with the cost, location and engineering skills set to meet their exacting needs.

We are seeing dynamic activity across most regions, and I would like to give you a recent example of our success at capitalizing on it. There are strong market conditions in Tijuana currently, where we recently developed over 500,000 of spec building, of which, over 50% was leased before delivery, demonstrating our ability to anticipate market activity.

Before I turn the call over to Juan to discuss the details of our third quarter results, I will also like to point out that Fitch renewed our BBB minus rating with a stable average.

In addition to the cash that our business generates, our credit rating allows us to inexpensively fund accretive investments as we continue selectively building our best property portfolio and adding to our lend bank to capitalize on opportunities that we see over the next 2 years and beyond in current market and new geographies. And when we do not find the right opportunity in which to invest capital, we will continue to return -- returning to Vesta shareholders via dividends as well as stock buyback as we did in the recent quarter, when we repurchased 26.8 million shares.

We will also then take buybacks when the discount commodity falls too low.

Lastly, on this subject, Vesta's Board has approved the cancellation of 25.3 million treasury shares, which is a clear signal of our focus to create value for shareholders.

Needless to say, we are optimistic about what we're seeing in the market and with Vesta's prospects.

Let me now turn the call to Juan, who will discuss our quarterly financial results in more detail. Over to you, Juan.

[Juan Felipe Sottil Achuttegui, executive]

Thank you, Lorenzo. Good morning, and thank you all. With the increase in third quarter revenue and an expanded net operating income margin, EBITDA grew 21.4% year-over-year, representing a 90 basis points expansion in EBITDA margin. Thanks also to our share repurchase, EBITDA per share increased nearly 25%. In addition to the robust leasing activity that Lorenzo highlighted, revenue also rose as our average price per square foot increase is likely. Also, lease renewals dropped 2018 and 2019 maturities to 1.2% and 6%, respectively. Operating cost increased 3.4% with a 5.7% increase in cost related to investment properties, generated in rental income.

For the quarter, net operating income increased nearly 21% year-over-year.

Next, moving further down the income statement of administrative expenses rose nearly 19%, as we added employees and invested in marketing to support Vesta's growth effort. The increase was also due to increased long-term employee incentives.

Also, noteworthy on the expense side, was the 15.3% increase in interest expense, which reflects a higher level of debt stemming from the issuance of debt last May to help fund our development pipeline.

The relatively low cost of funding that Lorenzo referenced is due to Vesta's optimal level of leverage, approximately 35%, and a debt maturity that averaged 7 years.

Moreover, the interest rate on all our debt is fixed.

This funding combined with Vesta's strong cash flows are another significant scale advantage that we have in our industry.

As regards entering new markets, we will only make investments that generate at least the same level of profitability and returns that we earn in our current markets.

Funds from operations declined just over 73% due to higher taxes stemming from an appreciation of the peso during the quarter as well as an increase in the financial results.

The current tax on Vesta operations was $15.1 million, of which the exchange related portion was $5.5 million.

As a reminder, approximately 87% of Vesta rental income is denominated in U.S. dollars. On a per share basis the decline net fall was partially offset by the share repurchase during the year.

Compared to last year quarter, our CapEx increased 26% to nearly $30 million. These investments are related to the construction of new inventory and build-to-suit buildings in Ciudad Juarez, Tijuana, Aguascalientes, San Miguel de Allende, Silao and San Luis Potosí.

In total, we are currently developing approximately 1.9 million square feet of new GLA representing nearly $80 million in investment.

During the third quarter, we added 2 build-to-suit buildings for Smurfit Kappa and RSB Transmissions, which are expanding their operations.

We also added 2 inventory buildings to our development portfolio for which the weighted average expected return on cost was just over 11% for the quarter.

Although we are expanding Vesta's pipeline we want to emphasize -- and we're not losing sight of optimizing our existing portfolio.

Vesta's stabilized portfolio expanded approximately 17%, with occupancy increasing 60 basis points to 96.4, while our same-store portfolio grew 16% and occupancy increased 100 basis points year-over-year towards historical high of 98% that Lorenzo highlighted.

This total property portfolio grew nearly 1.5% during the quarter while our vacancy rate remained unchanged at 8.1%, supported by leases totaling 1.1 million square feet.

We also continue to add to Vesta land bank, which grew 4.6% sequentially to 33.6 million square feet of gross land area.

I finish here with guidance for 2019. We expect increased rental revenue between 12% and 14% with a 96 NOI margin and an 85% EBITDA margin.

That concludes our prepared remarks.

Operator, let's open the call for questions.

[Operator]

[Operator Instructions]

Our first question comes from the line of Eugenio Saldaña with GBM.

[Luis Saldana Flores, analyst]

I have 3 questions for you. The first one is do you think that this positive perspective that you are mentioning after trade agreements and all that could alter the mix of development in terms of build-to-suits and speculative in going forward for you? That's the first one. The second one, if I recall, Lorenzo, you mentioned during the Vesta anniversary that you might expand your footprint to new regions in Mexico. At this point, what is the advance on this matter? The third one, besides the financial finally benefit of cancelling these stocks, does the systems had to do with taking tax benefits, I mean, for holding the shares for more than a year and preventing from paying any taxes or something?

[Lorenzo Dominique Berho Carranza, executive]

[Foreign Language] Thank you very much for being on the call, and thank you for the questions. I'll answer the first 2 questions, and I will ask Juan to answer the third one. Technically, we have seen that seems -- there is no clarity regarding the new trade agreement. The pipeline has slightly picked up, which is a very good signal that some companies that have some projects on hold are now returning to the markets to analyze some of the parties that they were previously analyzing. Therefore, we believe that there could be more activity, more recent activity. And regarding your emphasis on build-to-suit spec building, as you know, we have a strong -- today we have a very strong preference towards our strategy on spec buildings since we have been able to have more market intelligence to anticipate the demand and even at controlling the standard type of the construction of the buildings. And having standard buildings with multitenant buildings has been -- has enabled us to accommodate all sorts of tenants -- logistics tenants, live manufacturing tenants -- and we think that that has been very well received strategy and with very accretive strategy from Vesta, because we are getting -- having pretty high returns, over 11% on the spec buildings. So of course, the build-to-suit projects, we are still very close to them. We have a couple of them on our pipeline, and we think that some of them will materialize also in the next quarters.

Just to give you an idea on the pipeline that we are seeing, in average, let's say, some years ago, or quarters ago, we had an average between 35 to 40 pricings per month and -- which is a very good number. And as you know, the recent activity in the past was very good. Well, that particular pricing activity increased to between 60 to 75 pricings just in the last couple of months, actually -- yes, in the last couple of months. So this is a very good signal. We are very active. I think this also is a sign that many of potential clients are analyzing some of the spec buildings we did in the past. So that's also a result of having -- have been -- have made the right decisions in the right moment. In terms of the new geographies that I mentioned, definitely, well -- Vesta is always open to analyze new opportunities. Nevertheless, we're very cautious and will be entering those markets where we believe we can maintain the same type of profitability that we have been able to find in the markets where we are leaders. Just to give you an example, the type of deals that we do in Tijuana, in Baijio and central region are with returning cost of 11% U.S. dollar, long-term leases, high-quality tenants. And I just want to be very cautious that if we enter other markets, we also want to maintain high profitability. We don't -- wouldn't like to enter just because. So therefore, we are analyzing some opportunities in some of the main markets of Mexico, particularly in Mexico City and in surroundings -- Guadalajara and Monterrey.

[Juan Felipe Sottil Achuttegui, executive]

Regarding the shares question that you had, Eugenio. Look, as I've been saying over the past quarters, the tax implication of treasury shares really happened once you have the shares for more than one year. Then you have to pay taxes as if you had paid a dividend, roughly speaking. Most of our share repurchase, most of the balance of our share repurchases have already more than one year. There is only a smaller portion, around 10 million shares or something to that effect, 8 million shares, that have been purchased that have almost a year, but not quite a year, so most of the shares have already paid the taxes. The cancellation of the shares is really our -- as Lorenzo pointed out -- is our willingness to really underline that share buybacks are really accretive to the shareholders. We perceive that there was interpretation in the market that those shares had other uses. We wanted to maintain the flexibility but at the end of the day, we want to underline to the shareholders that the sole purposes of share repurchase from now on is to increase shareholder value directly.

[Luis Saldana Flores, analyst]

Thank you. Just a follow-up, Lorenzo. On those pricings, I mean, what is the historical hit rate on those pricings?

[Lorenzo Dominique Berho Carranza, executive]

That's a good question. I mean, just thinking, without having the right number but just thinking about the results that we have had in the past, we have been leasing -- making third quarter probably over 12 leases, between 10 and 15 leases, with a number of prices that I just mentioned. So probably a good hit ratio would be, yes, somewhere in the, probably like 20% to 30%, probably.

[Operator]

Our next question comes from the line of Victor Tapia with Bradesco.

[Victor Tapia, analyst]

So under -- we have seen like that you are saying that increases, recent activity -- which is to remain or that should remain very, very good given the trade agreement with the U.S. But looking through the site of the competition, how are you guys seeing the -- how are they seeing this increase recent activity? Are you guys seeing some new entrants in the market? Or some vacancy pressure on rent cost going forward?

[Lorenzo Dominique Berho Carranza, executive]

Great. Thank you, Victor for your question. I think

[Audio Gap]

the good decisions that Vesta took in the past couple of years is to really be close to the markets and really identify important investment opportunities. And in the last couple of years, we have identified that Vesta has maintained its leading position and has taken a step forward towards developing, towards acquiring land and anticipate to potential demands. I don't think that other competitors were in the same track. I think that many of them were lacking in terms of investment -- investing. And I think that this for some of them, it's still going to take them a while until they identify the opportunities, acquire land, put the infrastructure in place, start developing spec buildings. And I think that that particular ride is going to be an opportunity, a good opportunity for Vesta as long as we maintain our leading position and even that there could be some smaller competitors, realty fundamentals are stronger than ever. I mentioned the case of Tijuana. Tijuana has a vacancy rate of 2%, and that's why we decided to make an over $30 million investment on the spec buildings that I recently mentioned, because we know that realty fundamentals, certain ones, are driving the profitability and the returns of the project. In Tijuana, for example, rents are increasing in dollar terms at a very attractive rate. That's why we have been able to do accretive investments in the region while maintaining construction costs down and also being very disciplined on the type of tenants that we have. And that characteristic is one that we want to hold in most of the markets where we're at, be very cautious and on how competition is doing. And as long as competitors are, let's say, at some point disciplined, I think that Vesta is going to take advantage of that.

[Victor Tapia, analyst]

Okay. So just to make clear you guys believe that competition should increase, but you believe that Vesta is in better position compared to new competitors, is that right?

[Elias Laborín, executive]

Absolutely. And probably just to give more clarity I think it's also a matter of how well capitalized the companies could be. And I think that Vesta has a solid balance sheet, Vesta is well capitalized and no numbers showing our peers are in a similar situation. They are shrinking and that's why they can -- they have limited access to capital right now and that could be another potential advantage.

[Operator]

Our next question comes from the line of Pablo Ordóñez with Itaú BBA.

[Pablo Ordóñez, analyst]

Can you -- for the guidance provided for next year, can you give us some color on what do you expect for development CapEx in year with all this -- very active pricing and request for proposal activities? And also what are your plans to fund this CapEx? And also related to this, should we read the decision to cancel the shares that you had in treasury that -- as you are more confident that you can fund your future growth with internal capital?

[Lorenzo Dominique Berho Carranza, executive]

Look, regarding the CapEx, we typically invest around $125 million per year. That includes buildings as well as some replenishment of land. I expect the next couple of years to have a similar CapEx level. Last year, we've had a bigger investment in CapEx in what I believe that was some extraordinary year. So $125 million is a good number to have on the back of our minds. And not all of it goes to buildings, I underline around $100 million goes to buildings, $90 million goes to buildings, the balance goes to land plus infrastructure. Regarding the decision to cancel the shares, yes, indeed, we always wanted to keep the shares to have the optionality during the Vesta Vision 20/20. However, I believe that with the CapEx levels that I underlined and the increase on the leverage that we could do over the next 2 years on very pointed, I mean, on a smaller scale and everything -- earnings, which play a very important role on funding the company -- I believe that we made the right decision. The board made the right decision to basically underline to shareholders that the objective of share repurchases is really value creation, and we wanted to be very clear on underlining that to our shareholder base.

[Pablo Ordóñez, analyst]

Okay, understood. And another question, regarding the growth outlook, Lorenzo, Juan, are you seeing opportunities in the logistics segments and this type of -- this business segment? Does it meet the -- your business profile, the maturity of the lease terms? The quality of the tenants, so on and so forth?

[Lorenzo Dominique Berho Carranza, executive]

Yes, definitely. As you know, roughly 30% of our portfolio is logistics. So we have been very close to the logistics sector. So one out of every 3 leases that we sign is related to logistics. Nevertheless, we're very cautious on maintaining the same lease profile that we have in our portfolio. So as long as the logistics client is a -- an investment grade client is a dollar denominator lease, and it has a lease term of approximately 5.8 years, which is our average, we feel comfortable. What we don't like is short-term leases with low credit rating companies in pesos. We think that, in the long run, that really impacts the value for our shareholders, and we are very disciplined in trying to achieve good value creation for shareholders. And that's why we are also very cautious on what type of logistic tenants we take.

[Operator]

[Operator Instructions] Our next question comes from the line of Adrian Huerta with JPMorgan.

[Adrian Huerta, analyst]

Two questions. One is, your views on asset recycling. And the second one is, if you can just tell us some, from, which type of clients are the ones that are pushing the demand high-end the last few months. Is it U.S., European nation client, and of which type of sectors?

[Lorenzo Dominique Berho Carranza, executive]

Sure, hola. Thank you for being on the call. Yes, I think well, as you know Vesta has always had flexibility on holding different strings in order to find the best alternatives to capitalize the company. We did it when we raised equity back a few years. We did it when we raised debts and financed the company on competitive terms. And I think that asset recycling could be also an alternative looking into the future, if the prices are right. So I think that having that flexibility is good for the company and there could be opportunities in the future to recycle capital, we could do so. As you know, having over 30 million square feet, having some sales of a portion of -- a small portion of our portfolio would not relieve our revenue base and I think could send us -- could see now. In the end, if we're making the decisions in order to create value for shareholders, not necessarily because we want to get -- we wanted to get real assets. And secondly, regarding the -- your question on the type of tenants, we're seeing still demand from same regions as we have been seeing in the last years. And it's Asia, it's the U.S., it's Europe. I think that it really has not changed that much. I think one of the -- a couple of leases that we signed in Tijuana recently were with American companies, I think that -- in the end American companies want to be competitive, American companies want to be profitable. And in order for them to be profitable, they need to keep expanding their operations in Mexico. And that's why we are still seeing that they are growing their footprint in the country. And as you know, the Asian companies in the automotive industry have expanded in a very important way as well as European companies, which are considering Mexico as an important logistics and manufacturing platform.

[Operator]

[Operator Instructions] There are no further questions in the queue. I'd like to hand the call back to management for closing comments.

[Lorenzo Dominique Berho Carranza, executive]

Thank you very much, Doug, and thank you, everyone, for being in the call. As I stated at the beginning of the call, we're really focused on driving NAV higher and will do in a disciplined manner. Leveraging our leading market positions, scale, powerful market intelligence and strong balance sheet and funding capabilities to capitalize on opportunities in current markets and in new ones over the next 2 years and beyond 2020.

As was stated, we will remain focused on optimizing the current corporate portfolio, and we will only invest in new geographies when we can achieve the same level of profitability and returns as we generate in current ones. And as I noted earlier, we will return capital when we are unable to effectively deploy it or when Vesta stock trades too far below NAV. Thank you for the trust that you continue to place in me, the rest of the executive team and the many other employees who are behind the success of our company.

[Operator]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.