Macquarie Mexico Real Estate Management SA de CV

OTC:DBMBF

Earnings Call Transcript 2022-Q1

[Operator]

Good morning, and welcome to FIBRA Macquarie's First Quarter 2021 Earnings Call and Webcast. My name is Melissa, and I will be your operator for this call. [Operator Instructions] I would now like to turn the conference over to Nikki Sacks. Please go ahead.

[Nikki Sacks]

Thank you, operator, and Good morning, everyone. Thank you for joining FIBRA Macquarie's first quarter 2022 earnings conference call and webcast. Today's call will be led by Simon Hanna, our Chief Executive Officer. And to answer any questions you may have at the conclusion of today's prepared remarks, we also have Andrew McDonald-Hughes, our CFO.

Before I turn the call over to Simon, I would like to remind everyone that this presentation is proprietary and all rights are reserved. The presentation has been prepared solely for information purposes and is not a solicitation of an offer to buy or sell any securities. Forward-looking statements in this presentation are subject to a number of risks and uncertainties. Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by the forward-looking statements. These forward-looking statements are made as of the date of this presentation. We undertake no obligation to publicly update or revise any forward-looking statements after the completion of this presentation, whether as a result of new information, future events or otherwise, except as required by law.

Additionally, on this conference call, we may refer to certain non-IFRS measures, as well as to U.S. dollars, which are U.S. dollar equivalent amounts, unless otherwise specified.

As usual, we have prepared supplementary materials that we may reference during the call as well. If you have not already done so, I would encourage you to visit our website at www.fibramacquarie.com and download these materials. A link to the materials can be found under the Investors Events and Presentations tab.

And with that, it is my pleasure to hand the call over to FIBRA Macquarie's, Chief Executive Officer, Simon Hanna.

[Simon Hanna, executive]

Thank you, Nikki. Good morning, and thank you for joining us. On today's call, I will discuss our first quarter 2022 results, provide updates on our growth initiatives and capital position and our outlook for the remainder of this year. As you would have seen, it was announced last week that Juan Monroy has stepped down and that I have been appointed CEO. I'm honored to be assuming this role, and I'm excited to execute on our well-established strategy.

On behalf of the entire FIBRA Macquarie team, I would like to thank Juan for his leadership and contributions to FIBRA Macquarie over the past 10 years, as well as his support in assuring a smooth transition. Further, I would like to congratulate Andrew McDonald-Hughes on his appointment as Chief Financial Officer, and I look forward to continuing our working relationship on FIBRA Macquarie Mexico that already encompasses the combined time span of 2 decades.

We have also taken the opportunity to [ include ] our corporate governance by separating the roles of CEO and Chairman of the Technical Committee. In doing so, we welcome Mr. Nick O'Neil as Chairman and Macquarie's Sole Manager representative. We are also honored to welcome Mr. Alonso Garcia-Tames, as a holder appointment made at last week's AGM. We look forward to both Mr. O'Neil and Mr. Garcia-Tames making valued contributions.

The fundamentals of our business are as strong as ever. Our operating results for the first quarter delivered a strong increase in AFFO per certificate to MXN0.6558. This represents a year-over-year increase of 17.1% and an impressive 6% quarter-on-quarter step up. Importantly, this improvement was driven by top line growth, complemented by disciplined cost control. It is pleasing to see the operating performance translating to AFFO margin expansion with a meaningful 448 basis points increase over the prior corresponding period.

We also continue to make good progress in our industrial development, which should contribute to our earnings next year and beyond. Additionally, subsequent to quarter end, we made enhancements to our balance sheet with the refinancing of our unsecured bank facility, thereby improving our cost of borrowing, extending our maturities and positioning us to execute on our organic and development growth strategies.

Our strong results continued to be driven by outperformance in our well-positioned industrial portfolio, as well as an ongoing recovery in our grocery-anchored retail portfolio. With this favorable start to the year, including overall higher occupancy and rental rates, good leasing momentum and a sustained recovery in the retail segment, we have taken the opportunity to reaffirm full year guidance.

Overall, market conditions remain constructive. The demand for manufacturing and logistics real estate continues globally, and Mexico remains an important beneficiary. Industrial sector tailwinds continue to be supported by supply chain disruptions and other macro trends driving nearshoring, ongoing labor market challenges in the U.S. and China, as well as the growth of the Mexican e-commerce sector. We believe all these long-term structural drivers will benefit the Mexican industrial real estate sector, not only in the short term, as we're currently observing, but also for many years to come.

In our industrial portfolio, we posted a solid first quarter result with a 6.5% annual increase in NOI, as we realized positive metrics across the board. We are thrilled to report that our closing occupancy of 97.1% marks a new record and is up 108 basis points sequentially and 279 basis points over the last 12 months. These occupancy gains were made in tandem with a 3.7% increase in average rental rates that also reached a record level. The combination of higher occupancy and higher rents translated into underlying base rent income of approximately $41 million for the quarter. That's up $2 million on a quarterly run rate basis from 1Q, '21 and is also a record level of quarterly based rental income from our industrial portfolio. Looking ahead, we consider that the occupancy tailwinds and below average lease rollover for the remaining 2022 quarters supports our positive outlook for the rest of the year.

New leasing activity for the quarter absorbed 481,000 square feet of GLA with 6 new customers across 5 markets. Notably, new leasing deals included Asian domiciled electronics and auto parts manufacturers. This includes examples of nearshoring, such as a German manufacturer of industrial components, who has relocated production from China to Mexico, establishing a presence in Mexico for the first time to serve their customers, who are also relocating from Asia. Renewal leases comprised 14 leases and 713,000 square feet, driving a healthy retention rate of 83.5% over the last 12 months. As we look ahead, we have manageable expirations with approximately 10% of our lease GLA set to roll over in the remaining 9 months of 2022.

Turning to our industrial development program, we are making progress in our projects under development and expansion, approaching almost 1 million square feet of GLA under construction. We are nearing completion on the first phase of our Apodaca development project and anticipate to deliver this 183,000 square foot building in the coming months. The property is being delivered into the market with the backing of strong tenant interest that gives us confidence in achieving a favorable leasing outcome.

In the Mexico City metropolitan area, we are continuing the development of 2 buildings, which will deliver more than 700,000 square feet of Class A industrial GLA in this important market. We expect to deliver both buildings during the second half of 2022.

We are also nearing completion on a 46,000 square foot build-to-suit expansion in Hermosillo with an attractive 11.8% [ dollarized ] yield on cost. These development projects are being built to lead specification and contribute -- should contribute to NOI growth in 2023 and beyond.

Turning to our retail portfolio, we have gradually emerged from the impacts of COVID and the green shoots we have been observing and reporting to you in the back half of last year are now starting to be reflected in our financial results. Reported foot traffic in our portfolio has rebounded, up 42% year-over-year. We delivered annual NOI growth of 9.3%, as we saw strong rent collections and lower discounts. Excluding the impact of noncash straight-line rent adjustments, adjusted NOI was, in fact, up 27.7%, which we considered to be more representative of the progress made in the operating performance of our properties. Of note, rent discounts for the quarter were just [ MXN 3 ] million, lower sequentially by 66% and our fourth consecutive quarterly decline.

Collections were up 31.2%, reflecting underlying revenue trends that are benefiting from the gradual unwinding of discounts. We are also seeing the positive impact of a higher inflationary environment with contractual rent increases of 7.1% in respect of contracts with the lease anniversary during the quarter, representing 25% of the retail portfolio based on annualized rents.

Whilst the leasing environment has not returned to pre-pandemic levels, we were encouraged by the progress made for the quarter. Lease renewal activity was strong, as we signed 41 leases in the quarter totaling 23,000 square meters. The strong start to the year was driven by some large entertainment and restaurant renewals, which was particularly pleasing to see following [ green ] leases that we executed on last quarter are reflecting a consolidation of the ongoing recovery in our nonessential tenant segment.

FIBRA Macquarie's balance sheet remains a pillar of strength. As of quarter end, we had MXN 5.1 billion of liquidity, inclusive of unrestricted cash and drawing capacity on our committed revolving credit facility. Our real estate LTV is 35%, and our net debt-to-EBITDA multiple is 5x within range of our long-term targets.

Subsequent to quarter end, we closed on a $425 million sustainability-linked to unsecured credit facility. As a result of the transaction and taking into account related interest rate swap transactions and working capital drawdowns, FIBRA Macquarie's total proportionate debt balance currently stands at $836 million, carrying a weighted average cost of debt of 5.2%, with an overall fixed rate indebtedness level of 92%.

Looking forward, we will continue along the path, which we have been progressing. We remain acutely focused on maximizing total returns on a per certificate basis, with a prudent and disciplined capital management strategy that it is aligned and integrated with sustainable ESG practices. We will continue with our prudent sourcing of capital through a combination of retained AFFO, responsible use of leverage and opportunistic asset sales.

In terms of capital allocation, our most attractive opportunity is executing on our industrial development program, which currently has 1 million square feet of GLA under construction in our core markets. In addition, we maintain a robust pipeline of land acquisition opportunities. Moreover, our MXN 1 billion certificate for cancellation and buyback program has been extended through to June 2023. We remain as focused as ever in evaluating our path to closing our sustained discount to NAV. Our NAV is supported by independent valuations, which are underpinned by historically strong market fundamentals and a growing data set of private market transactions, pricing at unprecedented levels.

We are well capitalized with the liquidity and flexibility to execute on our growth CapEx strategies, including driving internal growth and selected developments. As part of our efforts to provide best-in-class reporting disclosures, this quarter, we have added in our supplementary information materials additional detail with regards to our lease portfolio composition. There are 2 key takeaways that I would like to highlight. First, 58% of our total annualized rent as contractual increases based on either Mexican or U.S. CPI. Second, in our industrial portfolio, lease renewals made during the first quarter have been executed with a lease renewal spread of 14%.

With regards to our outlook, we are reaffirming our 2022 per certificate guidance for AFFO of MXN2.50 to MXN2.55 and a distribution of MXN2 per certificate. In line with our prior guidance, we authorized the first quarter cash distribution of [ MXN 0.5000 ] per certificate.

I want to reiterate our confidence as we look ahead. Through proactive asset management of our best-in-class portfolio, we have maintained higher quality assets with overall record occupancy and positive leasing momentum. I'm excited and optimistic, as I assume the position of CEO. I want to thank the entire FIBRA Macquarie team for their ongoing commitment, and it is through their talent and energy that we have been able to deliver such impressive results.

With that, I will ask that our operator open the phone lines for your questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Alan Macias with Bank of America.

[Alan Macias, analyst]

Just a quick question on average rents. I see in the industrial sector, we're up [ 3.7% ] in the retail, 4.1%. Can we expect this rate to be higher going forward just because inflation keeps being at high levels, more towards 5%, 6%. Is that a reasonable assumption?

[Simon Hanna, executive]

Thanks, Alan. And yes, look, I'd say that we -- as we just disclosed, we do have about 60% of our lease book that has that escalation exposure directly to CPI. So as we go through the year, we should obviously see that, that being reflected on a rolling last 12 months basis. So -- and that's not going to change. So we are starting to see that benefit in the last quarter or so. which is pleasing to see. And we do think that the lease book has a good deal of exposure to that.

Obviously, there's other factors that go into the average rental rate, which is sort of impacting the overall outcome. And at the moment, with regards to retail, we are seeing flattish renewal spreads, which we think is a good outcome just as we continue to stabilize the portfolio. So hopefully, that will also pick up a little bit from where we are in Q1, as the recovery in the retail sector picks up, particularly in the nonessential segment.

And with regards to industrial, really pleased there to see over and above the exposure that we have to CPI on the lease renewal side, some impressive pickup on a year-over-year basis for the lease renewal rate in double-digit territory. But let's see where that goes in the remaining quarters. But I think we're off to a good start in the year and reflective of a pretty strong fundamentals in the industrial sector, and as I say, recovering environment in retail.

[Operator]

Our next question comes from the line of Vanessa Quiroga with Credit Suisse.

[Vanessa Quiroga, analyst]

So regarding the [ REITs ] appraisal growth that we have seen and that may continue, do you expect to use that i.e. potentially lower -- to value, lower leverage levels to basically use that additional firepower for development?

[Simon Hanna, executive]

Yes. Look, we've been really happy to see the increase in valuations over the last 12 months, seeing industrial up around 12%, retail, again, sort of close to 10%. So I think that's been good. And as you rightly note, we're seeing that translate to an LTV coming down, down to 35% impact for 31 March. So we're happy with that level. It is, as I said, within range of our target, where we like to be, over the long term, 35% or a tad below. So it does give us flexibility to, I guess, use the balance sheet. We have a committed revolver there for the next 5 years, almost [ $0.25 billion ] as well as our retained AFFO. So liquidity certainly is there to complement balance sheet flexibility.

I think over the medium term, we would be mindful of just making sure that we're staying within track of that long-term target for LTV of 35%. So certainly, I think we do have the ability to use that revolver a little bit to fund some of the great CapEx we have in front of us in terms of industrial development. And with that, with the resulting revaluation gain that we're seeing at the moment in terms of compression from development to stabilize, that will help normalize that LTV back to 35% type range. So I think that's the thinking going forward. I don't want to sort of go too much above 35%. But certainly, we have the capacity to do so to fund the growth CapEx in front of us.

[Operator]

Our next question comes from the line of Juan Ponce with Bradesco.

[Juan Ponce, analyst]

Regarding development projects, where do you see yield on cost for the rest of the year? I think you mentioned around the 11%, but do you see any impact from rising construction costs?

And my second question is on maintenance CapEx. What percent of rent should we expect for the rest of the year?

[Andrew McDonald-Hughes, executive]

Hi, Juan, it's Andrew here. Nice to speak with you. Taking the first part of your question, with the existing development projects we have under construction, we continue to forecast a range of 9% to 11% yield on cost for those active projects. We've been able to secure attractive pricing, I think, and in some of the -- in some cases, ahead of the large, I guess, uptick that we're observing over the last 6 months to 9 months, which is positive.

And then I think the other factor that we're also seeing to be able to, I guess, give us confidence in maintaining that NOI yield type guidance is the increase in rental rates that is catching up to offset those construction costs as well across those active projects. As you know, and we've spoken about before, we're very excited with the opportunity to deliver 183,000 square feet in Apodaca, which is on track for completion during the course of this quarter with an exciting pipeline of leasing interest in that project, and then advancing very well with respect to our Mexico City project with north of 700,000 square feet due to completion prior to year-end. So I think as it comes to 2022 contribution, our expectation and guidance doesn't take into consideration any contribution from those projects this year. And our expectation is that they'll contribute to NOI in the 2023 year.

[Simon Hanna, executive]

Yes. And complementing that, Juan, just with regards to the question on maintenance CapEx. Firstly, I'd say pleasing to see starting the year with an overall level of normalized CapEx TIs and LCs in line with Q4. So sort of seeing that sort of stabilize, if you like, at that level, at least quarter-on-quarter. That pencils out to be around 14.3% of NOI with respect to our industrial portfolio, which is the, by far, the large -- largest bulk of that maintenance CapEx, as you know.

So that 14.3% for NOI is within range. I'd say where we want to -- where we expect to be. We have been tracking a little bit higher than that last year, probably closer to 15%. I dare say that with regards to where we're seeing normalized maintenance CapEx, TIs and LCs as a percentage of NOI, we would expect it to be somewhere within that range, maybe sort of trending close to the -- to where we were last year, closer to the 15%, but moving somewhere around those levels.

[Operator]

Our next question comes from the line of Andre Mazini with Citigroup.

[André Mazini, analyst]

Simon and Andrew, and congrats on the new positions very well deserved. So my question is on a particular tenant, of course, Amazon in the U.S., it's the biggest probably industrial tenant out there, and we've been seeing recently that Amazon has been increasing their own warehouses. I think in 2020, it's something like 2% of their industrial footprint, and in 2021, it was 4%, [ at least ], this is a data for the [ USA ]. So market in the U.S. is super hot, maybe they're doing that because they even can find all their needs, right, in the rental market. Do you think there's a "risk" that happens as well, in Mexico saw some, some users actually wanting to own their warehouses given the market is pretty hot, rental rates are going up? Or do you think that's not going to be the case in Mexico.

[Andrew McDonald-Hughes, executive]

Andre, it's Andrew here. I think it's certainly interesting, the trends we're seeing and how Amazon is behaving in the U.S. market. I think one of the great benefits of the Mexican marketplace is we do have a fairly diversified market and in terms of sort of Amazon's level of participation, it's certainly important and growing, but doesn't form a significant footprint, as we -- as we see in the U.S.

I think to -- more to your point around -- around potential ownership, I think that there's a good chance we may see more potential ownership. However, I think what the trend historically has been, and we've seen through cycles is that these businesses want to invest in their underlying business. And generally speaking, that hasn't involved the ownership of their facilities. Obviously, there's certain trends around -- around different industry groups or geographies and cultural aspects of that as well. And for example, we do see perhaps higher levels of ownership of warehouse space amongst Asian manufacturers and operators than others.

But I think certainly potentially as rents become higher, but I do think that these businesses will be grappling with broader challenges with labor cost increases, supply chain disruptions, increases in costs more broadly. And so it will be a balancing act and think ultimately up to -- to those business leaders to make that determination. But I think from what we're observing in Mexico is where I don't think we're expecting that to be a significant shift or impact to the competitive landscape.

[Operator]

Our next question comes from the line of Francisco Suarez with Scotiabank.

[Francisco Suarez, analyst]

Congrats for the new roles, Andrew and Simon; and second, a big thank you for the overall disclosure on your lease structures. That's wonderful and very helpful. Precisely, the question relates with that. Regardless of how the overall lease structure is, can you walk us a little bit on the differences that are currently paying between the in-place rents and market rents across regions? Is there -- I think that it is obvious that in the Northern market, that difference is likely to be higher compared to other regions. But if you kind of give us a little bit of color on how that differences are between in-place and market rents and congrats for the results.

[Simon Hanna, executive]

No, thanks very much, [ Franco ]. And I guess when it comes to our lease rental trends, as we've been observing in this quarter, and I guess, prior quarters, we have seen that positive leasing spread and actually having that double-digit increase in the industrial portfolio, that's been great to see. I think where we see, I guess, trends going forward, it's obviously going to come down, as you say, market-specific, market-specific factors and property tenant specific factors there in terms of how that all washes out in the mix. So over the next 9 months, I think -- overall, I think it's fair to say that we expect to continue to see a positive leasing renewal trend with those markets, as you say, core markets in the Northern, in the Mexico City, I think being probably at the top end of the class.

Overall, as we've always said, generally speaking, we underwrite sort of closer to inflationary type levels, and obviously, we'll take all the upside that we can. So we obviously haven't provided any specific guidance on where we are seeing specific rental rates through our book going over the next 9 months. But I would say that you've hit the nail on the head. I think the core markets, we're expecting to probably see slightly above average rental rate increases compared to the market as a whole. Let's see how we trend if we can get to double-digits again for the next quarter and Q3, Q4, that's great. But certainly, as I say, we're not necessarily budgeting to do so.

[Operator]

[Operator Instructions] Our next question comes from the line of Anton Mortenkotter with GBM.

[Anton Mortenkotter;GBM, analyst]

Simon and Andrew, thanks for taking my question and congrats on your results and new positions. My question is regarding your distribution guidance. Your guidance implies a payout ratio a bit lower from what you guys were paying last year, and you guys have delivered a solid performance on the industrial front. I mean on this, could we expect a higher distribution for the year if this performance continues to improve?

[Simon Hanna, executive]

Yes. Thanks, Anton. And look, I think, obviously, we're pleased to have seen the step up around 6% year-over-year on distribution, and I'd like to grow the distribution over the long term in line with our AFFO growth. At this current level, having that sort of mid 70% payout ratio, we think that's prudent. It does allow us to have a decent amount of retained AFFO, somewhere around $20 million to reinvest in those accretive growth projects.

So at this stage, we're happy with maintaining that type of payout ratio and that level of retained AFFO, we think is suitable. So I think we'll take a longer-term view in terms of, let's say, we are at the end of the year and then beyond in terms of overall AFFO and maintaining that type of payout ratio level in the mid-70s, we think is about right for where we are at the moment.

[Operator]

Our next question comes from the line of Juan Macedo with GBM.

[Juan Pablo Macedo;GBM, analyst]

We saw that around -- well, yes, saw that around half of your contracts mature in the next 3 years. We were trying to see some color. How are you seeing the renegotiation dynamics there? Could -- is there [ a pace ], of course, price increases? Or what do you expect?

[Simon Hanna, executive]

Yes. No, thanks for that question. I think for industrial, we're seeing, as you say, 10% this year, and it steps up in terms of lease expirations on an ABR basis in the next year or 2. So obviously, immediate focus is to work through current year expirations. And I think off to a good start on that, as you know. And we think that the remaining quarters is manageable with -- especially with the current market backdrop.

I think we'll be opportunistic in terms of any ability to bring forward some of the 2023 [ plus ] expirations. Maybe there's the ability to do that this year, as we go through the year, but it'll be on a selective basis. Obviously, that's -- there's a balance there about getting that right and bringing forward lease expirations. I think always has a fine balance from a commercial point of view. But I think there is a good opportunity to do so. And we may be able to -- as we work through not just this year, but looking at the future year expirations, again, we feel good with the current market backdrop that we can get a good renewal outcome overall.

We're obviously seeing pretty healthy retention rates at the moment. And so I think certainly, the -- I guess, the bias is more in the landlords, I guess, caught in terms of negotiation power at the moment, and that should give us -- that should give us, as I say, a good renewal outcome over not just this year, but looking into 2023.

[Juan Pablo Macedo;GBM, analyst]

That's great to hear. And just a quick follow-up. You mentioned around 60% of your contracts are linked to inflation. Regarding the remaining contracts, could you provide some color on the ranges of price increment that you -- that we could be seeing in the next quarters?

[Simon Hanna, executive]

Yes. Absolutely. Look, in Page 40 of our supplementary information pack, we've given some detail there. And I think what you'll be able to take away from that is that the components that isn't subject to pure CPI, it's a combination of either fixed rate step-up or contractual increases. And on average for this quarter and the last 12 months, we're at around 3%, as the increase for that component, which is the sort of just over 42% remaining of the lease book that's not CPI. So 3 percentage type level for those components. Obviously, the complement to the majority of the book, which is -- which is up around 7% based on current CPI. So I think that's the sort of split we have at the moment. And certainly, if you look at Slide 40, that, that provides all the color with regards to that breakdown.

[Operator]

Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Hanna for any final comments.

[Simon Hanna, executive]

No, thank you, operator, and thank you for everyone participating in today's call. We look forward to speaking with many of you over the coming days and weeks as well as updating you again soon on our second quarter 2022 results. Thank you.

[Operator]

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