Macquarie Mexico Real Estate Management SA de CV

OTC:DBMBF

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, and welcome to FIBRA Macquarie's Fourth Quarter 2017 Earnings Call and Webcast. My name is Carmen, 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, executive]

Thank you, Carmen, and good morning, everyone. Thank you for joining us for FIBRA Macquarie's Fourth Quarter 2017 Earnings Conference Call and Webcast.

Today's call will be led by Juan Monroy, our Chief Executive Officer. And to answer any questions you may have at the conclusion of today's prepared remarks, we also have Simon Hanna, our CFO; and Peter Gaul, MPA's Head of Real Estate Operations.

Before I turn the call over to Juan Monroy, I'd 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 Investor Relations, Events and Presentations tab.

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

[Juan Monroy, executive]

Thank you, Nikki. Good morning, and welcome to FIBRA Macquarie's Fourth Quarter 2017 Earnings Conference Call. On our call today, we will review our operational and financial performance and discuss our ongoing strategies for driving long-term growth.

The fourth quarter was a combination of a solid year for FIBRA Macquarie, both operationally and strategically. I'd like to highlight 5 key accomplishments for the year. First, we delivered solid operational results in 2017 with AFFO per certificate growth of 8.6% and AFFO margin expansion of 200 basis points to 49.4%. We're able to achieve these results by concentrating on the fundamentals of the business with an experienced team and robust platform.

Second, we are effectively executing on our strategy to reinvest our capital, while at the same time, also increasing our flexibility to act opportunistically. Utilizing our retained AFFO and asset sales proceeds in 2017, we deployed or committed approximately $86.2 million of capital across expansions, developments, buybacks and debt repayment. During the year, we delivered [ 394,000 ] square feet of development and expansions and have an additional 134,000 square feet currently in process, along with a robust pipeline of additional opportunities. The protected weighted average yield on the life-to-date completed and in progress projects is 11.9%.

Through today, we have returned MXN 412 million to shareholders in the form of certificate buybacks as we repurchased 19.1 million certificates for cancellation. We are authorized to repurchase up to an additional 21.4 million certificates to complete the total authorization of up to 5%. This buyback program continues to represent a highly accretive use of capital as our certificates trade at a 36.4% discount to NAV and an AFFO yield of 11.2% based on the midpoint of our 2018 guidance and yesterday's certificate price of MXN 20.39.

Third, we enhanced our portfolio composition. During the year, we sold 5 assets, including the exit of 4 single-asset noncore markets. These sales generated proceeds of $28.3 million. Going forward, we remain committed to pursuing selective asset recycling opportunities, and over the medium term, we anticipate opportunistically recycling approximately 10% of our total GLA. These sales will be assets which we consider to be noncore based on a number of criteria, including market and property factors. Proceeds from opportunistic sales will be targeted towards expansion and development projects with a focus on core markets in growth sectors, such as logistics, aerospace and medical devices.

Fourth, we improved our balance sheet and financial flexibility, completing the final step in a comprehensive balance sheet enhancement. The actions we took extended the outstanding tenor of our debt with no material maturities until Q2 2021, increased the fixed rate portion to 95%; and increased our undrawn revolver facility to $218 million. We also reduced our real estate leverage down to an LTV of 40.1%, a solid 290 basis point reduction for the year.

Combined, these steps provide us with both long-term cost stability, particularly in a rising interest rate environment as well as meaningful flexibility to execute on our overall objectives.

Finally, we've further enhanced our corporate governance, an ongoing area of focus for us. As we have previously discussed, while we believe we already have one of the best structures in the industry, we also believe there is always room for improvement. To that end, during the year, some of the notable steps we took included the addition of the new independent members to the technical committee so that 80% of the members are now independent and subject to an annual investor consent.

The adoption of a series of new or revised governance policies and requiring that, starting in 2018, manager-appointed independent Technical Committee members reinvest at least 40% of their fees in FIBRAMQ's certificate to be purchased on the secondary market, which further increases alignment with certificate holders.

All in all, 2017 was very productive. We delivered robust financial and operating results, reflecting the strength of our portfolio, our deep real estate expertise and the advancement of our long-term strategy, resulting in increasing value on a per-certificate basis.

Now turning to our fourth quarter results. For the quarter, we reported AFFO per certificate of MXN 0.5363, compared to MXN 0.5531 in the prior comparable period. Positive revenue growth of 4.1% was offset by higher interest expense arising from the September $210 million fixed rate refinancing and some one-off property expenses.

We achieved favorable rental growth year-on-year and very strong leasing activity, particularly in renewals, demonstrating the quality of our assets, desirable locations and proactive approach to customer service.

In our industrial portfolio, compared to last year's fourth quarter, net income was down due to the movement in FX rates, along with the impact of asset sales completed in the quarter, resulting in an NOI decrease of 4.9%. The industrial portfolio occupancy rate as of December 31, 2017, was 92.6%. The 10 basis points change in occupancy on a net basis was attributable to a strategic sale of 2 fully leased properties in the quarter.

Rental rates improved 2.8% in the fourth quarter with a closing weighted average of $4.61 per leased square meter per month from the prior year. This rate increase was driven primarily by contractual increases along with positive renewal spreads.

We had a very active leasing quarter as we executed the highest volume of renewal leases in our 5-year history, signing 29 new and renewal leases, comprising 2.9 million square feet. This included 6 new leases totaling 237,000 square feet, which included the commencement of 2 completed expansions and 23 renewal leases totaling 2.5 million square feet.

Notable new leases in the quarter include a logistics company in Monterrey, a refrigeration manufacturer in Reynosa and a call center operator in Ciudad Juárez. Renewal activity was particularly strong in the quarter with 7 leases each greater than 100,000 square feet across various geographies and various types of customers, including manufacturing of automotive parts, medical supplies and diesel train components.

The diversity of these leases in terms of both geography and industry demonstrates the ongoing positive aspects of our portfolio and our market.

In our retail portfolio, fourth quarter NOI increased by 6.9% compared to last year's comparable quarter, driven by a 5.2% increase in rental rate. Leasing in the quarter was robust as we signed 51 leases comprised of 17 new and 34 renewals for a total of 6,800 square meters. We continue to see a solid backdrop for us in the retail sector as we benefit from stable consumer consumption and employment trends. Our portfolio is particularly well positioned, given our concentration of necessity-based retailer and focus on the top 3 metropolitan markets in Mexico.

Turning to our value-accretive expansion activity. During the fourth quarter, we deployed or committed to deploy $5.3 million on expansion projects. We delivered a 14,000 square-foot expansion for a manufacturer of plastic fasteners, automation systems and automatic doors in Querétaro; and a 65,000 square-foot expansion for an automotive parts manufacturer in Hermosillo. We also have 4 additional projects in progress, representing 134,000 square feet of GLA.

As we have discussed, we remain committed to owning a best-in-class portfolio. To that end, we are continuing to invest in expansion and development projects, along with pursuing selective recycling opportunities to enhance the portfolio composition.

During the fourth quarter, we sold 2 properties in Villahermosa and Durango, thereby completely exiting these noncore markets. The total sales proceeds were $22.3 million, which exceeded the book value of the assets.

Over the medium term, we anticipate opportunistically recycling approximately 10% of our existing total GLA, which we considered to be noncore based on a number of criteria. Dispositions could come in the form of single asset or portfolio sales.

Finally, as I mentioned in the beginning, our balance sheet is well positioned with significant liquidity, including $223 million undrawn on our revolving credit facility. No debt maturities in 2018 and strong visibility in our cost of funding with 95% fixed-rate debt. All of these provide us with the necessary flexibility to allow us to pursue our growth objectives. As we look ahead, real estate fundamentals in Mexico remained positive in both the industrial and retail sectors. While there is some marketwide uncertainty around potential NAFTA renegotiations and upcoming elections in Mexico, the favorable market dynamics that we have been experiencing continue.

In industrial sector, we continue to see stable demand in our key markets. Mexico maintains a competitive industrial platform for both export to the U.S. and to its major global trading partners. Furthermore, increasing consumption by an emerging middle class, along with continuing strong employment trends, supports a strong retail environment.

With this backdrop, we are introducing our 2018 AFFO and distribution guidance. FIBRAMQ estimates total FFO of between MXN 2.25 and MXN 2.30 per certificate in 2018. For the full year 2018, FIBRAMQ expects to make cash distributions of MXN 1.56 per certificate to be paid in quarterly installments of MXN 0.39 per certificate. This guidance assumes a continuation of our buyback program but does not include any potential dispositions or acquisitions.

Further assumptions can be found in our earnings release. And as always, we will provide updates if any of the base assumptions change leading to a revised outlook.

Before taking your questions, I would like to thank our entire team for their unwavering commitment and ongoing dedication to FIBRAMQ. And with that, I will ask that our operator open the phone lines for your questions. Carmen?

[Operator]

[Operator Instructions] And our first question comes from the line of Eugenio Saldaña with GBM.

[Eugenio Saldaña, analyst]

I have 2. Regarding your AFFO on consequential distribution guidance for 2018 and the pipeline of development, it seems that your purchases of certificates will be less than $2 million. I mean, do you expect to leverage up in order to repurchase more CBFIs, I mean, than the number, if I'm correct, I'm getting? And the second one is could you give us more color on those nonrecurring maintenance and repair expenses that you mentioned that diminished your AFFO for the quarter? That would be all.

[Simon Hanna, executive]

Thanks, Eugenio. It's Simon here. Yes, the buybacks going forward. We have about 21.4 million certificates. So that's around $23 million based on current levels that would be required to fund. Our retained AFFO is north of $30 million. So I guess, in short -- in principle, there is no refinement to leverage up, per se, to fund buyback. We have a surplus with -- as a standing point, we have a surplus retained AFFO. And furthermore, our long-term target with regards to leverage is what -- we're happy with our current leverage ratio of around 40.1%. Our long-term target is to take that down slightly closer to 35%. So I think from an operating cash flow point of view, we're fine to keep funding buyback through retained cash flow. Your second question on repairs and maintenance. That was, I guess, a year-end provision that was done with regards to, primarily, risk maintenance. A lot of those expenses, in addition, are relating to recoverable expenses. So we've also accrued to those expenses in this current financial year. The corresponding income hasn't been reflected in these accounts, so that will come through next year. So I think, overall, we see repairs and maintenance underlying as being pretty stable with regards to our quarterly trends.

[Operator]

Our next question comes from the line of Alejandro Lavin with Citigroup.

[Alejandro Lavin, analyst]

I have a couple of questions, please. The first one on your tax law position. So if you use the rest of your retained tax loss, let's say, at the end of this year or by the end of this year, would that change your payout ratios for dividends, of course, going forward? That will be my first one.

[Simon Hanna, executive]

Yes. Thanks, Alejandro. It's Simon here again. Yes, the tax loss position at 31%, that was around MXN 2.8 billion. Current forecasts, which is highly sensitive to FX, indicate that those tax loss positions will prevail through to the first half of next year, 2019. So after that, on a run rate basis, we obviously don't have a taxable income position. But that does not in any way impact the, I guess, the AFFO payout ratio. So basically, we are able to maintain our AFFO payout ratio and distribution trends with no impact as regards to reverting to a taxable income position next year.

[Alejandro Lavin, analyst]

Okay. Okay. And the second question. I mean, you have done a good job in recycling assets, in lowering the payout ratio, et cetera. So I mean, you're ticking several boxes, right, in terms of corporate actions. So going forward, let's assume that you have finished divesting noncore assets and you sort of finished buying back the 5% shares that you have a limit in the short term. So going forward, what kind of corporate actions would you consider? I mean, would it be more of the same or are there some other actions that you haven't used and that could use in the future?

[Juan Monroy, executive]

Yes. Thanks, Alejandro, it's Juan here. Very good question. Yes, as you noted, that we've been very proactive in executing our long-term strategy to create value for our investors on a per certificate basis, including recycling assets. And we'll cover the dividend reinvesting capital on accretive transactions, enhancing corporate governance, et cetera. For this year, the main focus will be to continue recycling our portfolio. As we noted, over the medium term, we believe that we still have around 10% for our GLA that we'll opportunistically likely sell. And the focus will turn a little bit from being asset gatherers to being asset creators a bit more. As you know, we've been sitting on the sidelines in terms of acquisitions as we believe that there are better investment alternatives, like buying back, growing shares or doing expansions for customers or doing development. So the focus for this year will be to continue with expansions and, perhaps, focusing a bit more on development with an important focus as well to diversify it into logistics, focus on the core markets of the country of Mexico City, Monterrey and Guadalajara with a strong focus on logistics. So that's the next thing for us. Obviously, we don't intend to change the risk profile that with our sort of medium-term target in terms of expansions in development pipeline will be to get to up to approximately 5% of gross assets. Really creating value and growth, but without changing the risk profile. So that's what the focus will be for us over the medium term, Alejandro. Thanks for your question.

[Operator]

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

[Pablo Ordóñez, analyst]

Also a follow-up on the strategy. Can you give us a little more color on what are you looking in terms of the CapEx, the expansions and developments for this year in terms of size? How much are you expecting to invest? Last year, it was around $25 million. Do you see that your portfolio still has enough room to add another $25 million in CapEx for expansions? That's my first question. And then a second question related to your operations. We have seen a strong pricing in the industrial segment with rent increasing 2.8% year-over-year. I would like to understand what the driver of this strong pricing and if you see a similar pricing this year.

[Juan Monroy, executive]

Yes, thank you for your question, Pablo. You know what, to predict expansion is always very difficult. However, based on what we have in progress today, plus LOI signs, plus discussions that we are having with our customers, my view is that the sum of your expansions and development for this year, we should be able to get to similar levels between $20 million to $30 million, and -- which is fairly consistent with our AFFO retention, et cetera. So I think that's doable. In terms of industrial, industrial rental rate question in terms of why it's growing and what's our view. It's a combination of factors. And we are very focused on customer service, a quick turnaround of lease negotiation. And obviously, it's also a reflection of asset quality and market conditions. We continue to see a fairly healthy balance between supply and demand. That plus leveraging our platform and our focus on the customer and really understanding their needs, has allowed us to increase our rental rate having a positive spread on renewals. What do we think is in store for the future? It's hard to say. Personally, we're not necessarily underwriting significant growth to industrial rental rate. This year, we have about 16%, 17% of GLA expiring. In fact, we already beat a lot of early renewals at the end of last year, and the rents that are expiring are around market levels. So we believe that inflation growth for the medium term should be reasonable, Pablo.

[Pablo Ordóñez, analyst]

Understood, very clear one. One quick follow-up. On the CapEx, you still to plan to fund this CapEx and the buybacks with the retained capital. Is that correct? And is there any room to pay down more debt this year?

[Juan Monroy, executive]

Yes, we intend to continue using our retained AFFO on an accretive basis, and that will be primarily funding our expansions and development pipeline. One to note as well that we have a revolver facility, that's significant, of more than $280 million. So that could be another resource that could be available for us. However, the focus will be primarily on operating cash flow and also on asset recycling as we sell some assets. We intend to do that -- those proceeds to reinvestment -- reinvest those into expansions and development.

[Simon Hanna, executive]

Yes. And I think just to follow-up on that. It is important to note that we do have flexibility on the balance sheet. But to the extent that we do have surplus cash flow coming in with -- through retained AFFO or asset sales, the drawn revolver currently at $40 million, that's basically payable immediately. So there's basically an efficient application of surplus cash to the extent we have it. And just taking a step back in terms of the leverage ratio. We're seeing that come down significantly for the year, 290 bps, from 43% to 40.1%. So that's a meaningful reduction. And what that gives us is an additional flexibility. Particularly as Juan said, we have an undrawn revolver of $220 million, which is also available on tap for immediate use, if we so wish to use it.

[Operator]

And our next question comes from the line of Marimar Torreblanca with UBS.

[Marimar Torreblanca, analyst]

I have 2 questions. The first one is on your asset sales. I understand you sold them at an above-book-value level. Is there any color you can give us on the cap rates the assets were sold at? And then the second one is I think it's great that you're giving disclosure on the use of your retained cash flow. But can you give us some sense of what kind of returns you're getting on these projects? A little bit more visibility on that will also be welcome.

[Juan Monroy, executive]

Yes, sure. In terms of the asset sales. Yes, we have disclosed the sale proceeds information, and that's above book value. We haven't disclosed the cap rate, they are along market levels. And there is a mix of occupied and vacant properties, but I will say that they are on a market-comparable basis, certainly, from a cap rate perspective and price per square foot as well. In terms of returns on expansions and development, if that was the question, I think we have provided a detailed information. Is that right, Simon? Could you elaborate a bit more?

[Simon Hanna, executive]

Yes, that's correct. So we do have -- on Slide 21 of our supplemental information pack, we do have a lot to-date track record of our expansions and developments across both industrial and retail. What that shows is that the NOI cap rate on all those projects for up-to-date attract development[indiscernible] is 11.9%. So I guess, that's a good indication of what we've been able to strike in the past, and our hope and expectation is that we continue at that approximate run rate going forward.

[Operator]

Our next question comes from the line of Jorel Guilloty with Morgan Stanley.

[Wilfredo Guilloty, analyst]

So I have 2 questions. First off, you were -- you mentioned that you had strong leasing volumes during the quarter. And I just wanted to get a little bit of color as to your perception of your clients. Is your perception that they're more maintaining their business? Is your perception that they're expanding business? I just want to get a sense if they are holding up and just keeping it stable just due to macro worries or political worries or if it's business as usual for them. That's my first question.

[Juan Monroy, executive]

Yes, that's a very good question, Jorel, and it depends on customer by customer. And trying to make sort of a more general assessment, I'll say that what we're seeing is encouraging. We're seeing a significant activity with our business expanding, and I think that's reflected not only in the renewals, but also in the expansions. So customers already in Mexico are, I'll say, with strong fundamentals, forward committed and continue to grow their businesses. New entrants into the market, I'll say, towards the end of last year, what we saw a little bit of a pause and people maybe taking longer than before to make long-term decisions. We're starting to see this year a little bit of a pickup on that front, people being more prepared to enter into long-term leases. So that's sort of the dynamics that we're seeing at the moment with both existing customers and new entrants to the country.

[Wilfredo Guilloty, analyst]

And then my second question is your share buyback, it's something that's picked up materially over the past quarter. You have about half done with what is available for you to buy back. And then you also provided guidance this quarter for your AFFO payout for 2018. It's about 70% from what we see. What I was wondering was, as you get closer to the end of the share buybacks, would you consider for this AFFO payout to go higher from 70%? Or is 70% just the right number for now? Ceteris paribus, as things are.

[Juan Monroy, executive]

Yes. No, I'll say it's not only from our perspective that number for now, but we see it more as sort of the long term -- it will be around 70%, not necessarily exactly 70%. But we see that payout ratio as being the right level to ensure that we have appropriate dividend coverage, we have the best dividend coverage in the industry for sure. And then, more importantly, as we've discussed in the past, we consider our operating cash flow to be the most efficient source of capital. And I guess, my answer will be slightly different if we thought that, over the medium to long term, we wouldn't have attractive accretive investment project. However, in a growth market like Mexico and given our real estate platform, we believe that we can continue to invest over the long term in expansions development and, at some point, maybe an acquisition as well on an accretive basis. So we see that payout ratio despite finishing on the buyback program as sort of the long-term trend for the company.

[Operator]

And our next question comes from the line of [ Francisco Medina ] with GBM.

[Unknown Analyst]

My questions have already been answered.

[Operator]

And our next question comes from the line of Gordon Lee with BTG.

[Gordon Lee, analyst]

Two quick ones. One is just a follow-up on the share buyback or the certificate buyback program. And I get different answers depending on who I ask, so I wanted to see what your interpretation of it is. But once you've completed it, once you've hit the 5%, is it something that you can reload, that you can sort of request authorization for another 5%? Or how does that work in terms of sort of continuing this buyback beyond that 5% initial threshold? And the second question is just on development activity. I guess, one of the -- one of the positives in the industry for the last couple of years is development activity has been pretty subdued. And I was wondering whether that continues to be the case, and if that's true across markets, whether there's certain regions in the industrial front where you're seeing development activity pickup.

[Juan Monroy, executive]

Sure. Gordon, thanks for your questions. On the buyback question, we have a pretty clear view and reading what was published at the end of -- in December of 2016. And from our perspective, it is very clear that you can only do 5% full stop, and that's it. Not -- you cannot go back for a new program. In our reading of what was published, that's very evident. I've also heard different interpretations in the industry. So I guess, it's an area where we, as an industry, will be discussing with the authorities for a proper clarification, if needed, at the right time. With regards to development. Yes, you're right, it has been -- new supply has been fairly flattish. A very healthy balance between supply and demand. We monitor this on a monthly basis. It has -- that relationship has deteriorated just a tiny bit over the last 3 or so months. The way we think about it is the number of months for supply to be -- new supply to be absorbed based on historical absorption. And that number throughout '17 was around 3.54 months, and towards the end of the year and early this year has increased a little bit towards 5, 6 months. It's still a pretty reasonable number. Obviously, it varies by market. There are markets, for example, like Guadalajara, where we've seen that relationship increase importantly. But we also believe that, perhaps, absorption -- historical absorption is not representative of what's to come as we're seeing quite a bit of activity. So I'll say it remains fairly healthy with some markets picking up on activity, but nothing of concern. And I think that's well reflected on a historical high occupancy levels and increases in rental rate.

[Gordon Lee, analyst]

Perfect. That's very clear. If I can just have one quick follow-up on the first question on the share buyback question. If your interpretation is right and you're not able to, let's say, reload the program, so it's 5 and done -- 5% and done. That -- but you keep your payout ratio at 70%, that -- those cash flows that would be directed as CBFIs repurchases, would you see those more likely to go towards additional development activities? In other words, do you see opportunities for your portfolio to absorb that? Or would that go more towards reducing leverage?

[Juan Monroy, executive]

I think that, in first instance, we have, fortunately, a very solid and flexible capital structure that will allow us to immediately repay down debt by saving on interest expense. And then gradually, as needed, then we'll fund our expansions and development pipeline. Just to be clear, ultimately, we do see us investing that capital in real estate, in expansions and development with a very good interim, given that we're paying down debt, given our flexibility on our balance sheet.

[Operator]

And I don't see any further questions. I would like to turn the conference back to management for any closing remarks.

[Juan Monroy, executive]

Thank you, Carmen, and thank you, everyone, for participating in today's call. We look forward to speaking with many of you over the next few days and weeks as well as updating you again soon on our first quarter 2018 results. Thank you.

[Operator]

Thank you. The conference has now concluded. Thank you for dialing in to today's presentation. You may now disconnect.