Prologis Property Mexico SA de CV

OTC:FBBPF

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. My name is Krista, and I will be your operator today. At this time, I would like to welcome everyone to the FIBRA Prologis Quarterly Earnings Conference Call. [Operator Instructions]

I will now turn the program over to your host, Kosta Karmaniolas, Head of Investor Relations. You may begin.

[Kosta Karmaniolas, executive]

Thank you, Krista, and good morning, everyone. Thank you for joining us for our first quarter 2018 earnings conference call. Today, we will hear from Luis Gutierrez, our CEO, who will discuss our strategy and market conditions; and from Jorge Girault, our Senior Vice President of Finance, who will review results and guidance; and also joining us today is Hector Ibarzabal, our Managing Director.

Before we begin our prepared remarks, I would like to remind everyone that all the information presented in this conference call is proprietary, and all rights are reserved. The information has been prepared solely for information purposes and is not a solicitation of an offer to buy or sell any securities.

Forward-looking statements during this call are subject to a number of risks and uncertainties. Our actual results, performance, prospects or opportunities may differ materially from those expressed in or implied by the forward-looking statements. These forward-looking statements are current as of the date of this call. We take no obligation to publicly update or revise any forward-looking statements after the completion of this call, whether as a result of new information, future events or otherwise, except as required by law.

Additionally, during this call, we may refer to certain nonaccounting financial measures. As is our practice, we had prepared supplementary materials that we may reference during the call as well. If you have not done so, I would encourage you to visit our website at fibraprologis.com and download this material.

With that, it is my pleasure to hand the call over to Luis.

[Luis Gutierrez, executive]

Thank you, Kosta, and good morning, everyone. FIBRA Prologis has started 2018 with terrific operating and financial results. I will begin with the macroeconomic environment. Favorable consumer trends, namely, a rising middle class, combined with growth in high-wage sectors, continue to drive consumption. This, along with a structural undersupply of modern logistic facilities, has propelled demand for our product. As a result, logistic real estate has outperformed the broader economy in Mexico, and FIBRA Prologis is benefiting.

Consumption has proven to be resilient despite headlines centering on politics and trade, and it has been broad based. The March 2018 data from the National Association of Self-service and Department Stores, ANTAD, showed real growth for comparable stores year-over-year. More importantly, increases were reported across-the-board by sales service stores, specialized chains, grocery and department stores.

E-commerce continued to grow at an extraordinary pace. Our sponsor, Prologis, signed 2, first of their kind in Mexico, build to suit development projects at Prologis Park Grande in the first quarter. One was for a 1 million square foot facility to Amazon, who's expanding their footprint in Mexico City. The second was also a 1 million square foot facility for MercadoLibre as they transition from peer-to-peer sales to direct-to-consumer. We expect e-commerce demand to accelerate and to expand beyond Mexico City to other major population centers.

On the NAFTA front, while renegotiations remain unresolved, we are encouraged by recent reports that progress is being made towards a deal. We continue to monitor the situation and have not seen any changes from existing customers in our broader markets.

Let me now discuss operating environment. The positive operating environment continues to be led by Mexico City and the broader markets of Tijuana, Reynosa and Juarez.

Starting with Mexico City. Market vacancy remains less than 1%. And along with very limited supply, we're seeing a strong absorption of the space and market rent growth. At the broader markets, demand has continued to exceed supply as almost all speculative development has stopped. We saw market vacancies decline to a favorable 4%. Market rents have continued to grow and is evident in the strong re-leasing spreads we are achieving at lease expiration. Some challenges, however, have emerged in Guadalajara. Several projects commenced at once amid new entrants, they're creating a softer market. Also, speculative development from local developers in Monterrey continues to be something we are watching. This undisciplined supply has driven market vacancies in these 2 markets above 8%.

Putting it all together, the national vacancy increased 20 basis points to a still healthy 4.5%. Our 2018 forecast continues to call for similar supply-and-demand levels relative to last year. Given the low overall vacancy, we expect to see market rents grow.

I would now like to spend a few minutes on our customers. Utilizing the research capabilities of our sponsor, Prologis, we conducted a review of our customer sentiments, their business activity and how they're utilizing our buildings. We surveyed a group of our customers from across our 6 markets. These customers represent a variety of industries, from e-commerce to the maquiladora. Key takeaway from the survey include: more than 80% reported good or better business activity in the first quarter compared to the prior year; 60% reported utilizing more of their existing space. This is a very positive indicator and usually predicts an increase in demand; customers generally have a positive view on global and regional economies. Gas prices, labor and regulatory issues as well as security concerns were all seen as having a negative impact. There was also less conviction on the presidential election, which suggests no near-term change to business activity. Looking ahead, almost 30% of our customers expect a significant growth in business activity this year, while another 50% forecast modest growth.

Customers are optimistic in general but cautious on certain key issues. The key takeaways is that business is continuing, and the near-term outlook appears favorable.

Before wrapping up, let me touch on our results of the quarter. FIBRA Prologis had excellent operating and financial performance. As a result of pushing rents, we achieved a 13.8% rent change on rollover. The combination of higher rents and lower interest rate expense resulted in FFO and AFFO increasing 13% over the same period of last year.

In summary, operating fundamentals for high-quality, well-located facilities such as those in our portfolio remain strong. Our customers are optimistic about 2018 despite the political uncertainty surrounding the upcoming presidential election and the NAFTA renegotiations. E-commerce will be a significant driver of incremental growth for our portfolio. And FIBRA Prologis is off to a great start. Our goal is, and always has been, to put the interest of our certificate holders first. We remain focused on delivering sustainable growth in an accretive manner.

With that, let me turn the call over to Jorge.

[Jorge Girault, executive]

Thank you, Luis. Good morning, and thank you for joining our 2018 first quarter earnings call.

FIBRA Prologis is off to a great start this year. Before discussing the results, I wanted to highlight that starting in the first quarter, FIBRA Prologis began reporting certain operating metrics such as leasing volume, weighted average customer retention and net effective rent change on leases that commenced in the quarter. In the past, these metrics were based on leases signed, so we believe this is a better description of current-quarter operations as it eliminates the lag between leases signed and the impact in our financial statements. As such, we have updated the prior 4 quarters to these metrics so these metrics are comparable.

Starting with our financial performance. FFO came in ahead of expectations at $29.3 million, an increase of 13% when compared to the same period last year. This increase was driven by higher NOIs from our strategy of pushing rents as well as lower interest expense from our 2017 refinancing activity.

Moving to operations. Leasing volume was 1.6 million square feet, with 88% of the total volume coming from renewals. Mexico City and Monterrey dropped almost half of the volume. Quarter-end occupancy was 96%, down 140 basis points over the same period last year. This was due to a combination of seasonal move-outs as customers tend to take temporary spaces during the holiday season and expected vacancies in Mexico and Ciudad Juarez.

Our strategy of pushing up rents and term have been working, though it has made a small percentage of our customers to leave. With that said, I'm putting this into perspective. We have had 14 quarters with occupancy above 96%. Net effective rent change and rollover increased 13.8% in dollar terms. This marks the fourth consecutive quarter above 10%. Rent change was led by Tijuana, Juarez and Mexico City.

Higher rents and reduction on -- of our bad debt expense has resulted in our cash same-store NOI increase of 6.6%, compared with the first quarter of last year.

Now let me update you with our balance sheet. At the end of March, we finalized a new term loan for $225 million. These proceeds were used to repay $72 million of secured debt, which was scheduled to mature at the end of this year, and the recast of our existing line of credit, increasing FIBRA's liquidity. This debt-for-debt exchange allow us to keep our leverage at the same level while improving our debt profile maturity. Also, we executed on 2 products this quarter that will limit the uncertainty around interest expense and FX. First, given the high probability of interest rate increase in the U.S, we have executed a swap, fixing LIBOR rate at 2.48% on the new term loan. Second, we entered into an option contract, allowing us to mitigate the potential impact of FX situation. As we have said, we want to take a prudent approach to our liability management and monitor how the geopolitical events continue to unfold.

Turning to guidance. I will only discuss changes, so for full review, please refer to Page 7 of the supplemental financial information. We have elected to put our dispositions on hold. I'd like to spend a moment to walk you through that rationale. As we started the preliminary disposition process, brokers indicated pricing could be above current valuations. As we move forward, we determined the tax gain on this specific asset would have created a scenario that would have taken capital out of FIBRA. As such, we have been exploring alternative strategies and hope to have a solution in the future. In the interim, we are putting the dispositions on hold until a solution can be found. This said, there could be one-off sales.

In conclusion, FIBRA Prologis has started 2018 with great results. We have a best-in-class portfolio of properties and one of the strongest and most flexible balance sheets in the sector. Given our emphasis on the best logistics and consumption market as well as our track record on delivering results, we believe FIBRA Prologis offers one of the most durable growth profiles in the logistics sector.

With that, I will turn it over to the operator for Q&A. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Sheila McGrath from Evercore.

[Sheila McGrath, analyst]

Yes, my question is on the same-store NOI, which was very strong this quarter. The expense line item last year was a pretty big swing up in first quarter, and this quarter, pretty big swing down. So I just wondered if you could give us a little bit more detail on that?

[Luis Gutierrez, executive]

Yes, sure, Sheila. Mainly for the NOI, in the same-store calculation that -- the main effect that we have in the expense line has to do with recuperation of bad debt, so that's why you'll see a lower expense line.

[Operator]

Your next question comes from the line of Dan McGoey from Citigroup.

[Daniel McGoey, analyst]

Two questions. Luis mentioned Mexico City market at around 1% vacancy, and I'm wondering if you could talk a little bit about the outlook going forward, whether you see that bringing more supply into the market over the next 12 to 24 months or whether it gives you maybe a superior ability to continue pushing rents higher? And then secondly, on the dispositions, Jorge, I think that this was a key part of the ability to potentially finance some of the acquisitions from the PLB pipeline. Without those proceeds, could you talk a little bit about, I guess, whether the alternative financing sources or whether that may effectively postpone the timing on those acquisitions?

[Hector Ibarzabal, executive]

Dan, this is Hector. Thank you. Thank you very much for your question. Effectively, as Luis mentioned in his opening remarks, Mexico City is presenting a very low vacancy. We have 0.7% of vacancy, which is basically only a fraction of vacancy happening in the market. There was a net absorption in this quarter of 1.6 million square feet, which is as much as the supply could give to customers, and construction starts were shy at 1.1 million square feet. We foresee Mexico City market as our most important market based on balance between supply and demand because their own ability of capacity to develop new space is going to keep on pushing rents, so we are very positive and very eager about this market. We're very well positioned. We have a large portfolio. And we feel in pretty good shape to keep on with the excellent operating results in this market.

[Luis Gutierrez, executive]

Dan, in relation to your second question, and this is Luis. So given what Jorge has explained in his remarks related to dispositions and given the tax constraints, the capital recycle is, for now, being put on hold. Meanwhile, we will be executing on our acquisitions on the low side of the range. As you can see, the guide is between $100 million and $300 million. So given the trade and the politics, which are involved in the rest of the year, I think it is time to be prudent and maintain a low loan-to-value. So we have a good amount of liquidity, and we have a pipeline coming from the sponsor. So once these events happen, we will reevaluate as the year progresses.

[Operator]

Your next question comes from the line of Eugenio Saldaña.

[Eugenio Saldaña, analyst]

This is for Hector. I actually have 2. I mean, following up on this decision to cancel your dispositions, I mean, you said -- you mentioned that you received offers, I mean, even above that pricing that you were thinking of. And how does this relate, I mean, with the view of your appraiser who, I mean, who placed a loss on the valuation of the portfolio, specifically for this quarter? And the second one is more a strategic -- strategy. I mean, are you pursuing any more steps towards protecting, I mean, the company for swings in the economic conditions? Or do you feel comfortable already, I mean, with where you are -- are you being for the future?

[Jorge Girault, executive]

Eugenio, this is Jorge. Thank you for your question. I'll take the first part of your question regarding the dispositions. In terms of valuation, quarter-to-quarter, if you compare our balance sheet, we were up $9 million. So the valuations were basically flat, which is a 0.3% or 0.4% decrease. So there's no increase in the valuations. So I wanted to comment that first because you said you saw the appraisals go down, but they're basically flat. Regarding the preliminary offers that we talked with brokers, and let me be clear, we didn't receive an offer for sale -- these were preliminary numbers that came from brokers regarding their estimates. These valuations were about 5% above our expectations.

[Luis Gutierrez, executive]

Yes. And related to the strategy and how are we prepared for any potential swings given, I guess, the election and the NAFTA renegotiation, I think we're very well positioned. I mean, number one, I think the portfolio is a very young portfolio. It is -- probably the portfolio that is the newest. The occupancy is very high. And mainly the geographic location is still in great locations where there's still a lot of dynamics from that push demand. So we also have a very strong balance sheet, 33% loan-to-value, which is a very prudent approach. And so from that perspective, we believe we are well positioned to take advantage of any opportunities that may arise in the future. And any fluctuations in FX are also taken into consideration. Jorge has already a hedge to guarantee the payment of the distributions, so I think we are well set for anything that may come.

[Operator]

Your next question comes from the line of Ramon Obeso from Scotiabank.

[Ramon Obeso, analyst]

I have 2 questions, if I may. The first one is related to acquisitions. When do you expect to close the acquisitions that you guided for this year? Could it be before or after the presidential elections? And my second question is, when do you expect the occupancy rates in Monterrey and Guadalajara will return to previous levels? Or what level should we expect for this year for these markets?

[Luis Gutierrez, executive]

Thank you for your question, Ramon. So as I said, we're going to be, for now, doing the acquisitions on the low side of the range. So you can expect about 50% of those acquisitions to hit in the second quarter, and the other 50% to hit in the fourth quarter. And now, I will pass over to Hector who will take the further question.

[Hector Ibarzabal, executive]

Thank you, Ramon, for your question. Effectively, out of the 6 markets in which we are participating, we have seen somewhat various situations in Monterrey and Guadalajara. I think that the strategy that we have of having the best products in the market and the right service is going to be -- start showing up. And we think that our portfolio is going to keep on having above-market occupancy in all the cases. Answering your question, in Guadalajara, we're expecting to have an improve in our occupancy, I would guess between 300 to 400 basis points between today and the end of the year. We're currently working in different transactions, and we are optimistic that we will get there. In Monterrey, our strategy to compete with local developers, again, is focusing on those companies which profiles really understand the quality of our products and are willing to pay an above price above market because this represents efficiency to them. In Monterrey, we have a very strong customer base. We would be expecting to have 100 to 150 basis points above our current occupancy by the end of the year.

[Operator]

Your next question comes from the line of Cecilia Jimenez from Santander.

[Cecilia Jimenez, analyst]

Maybe just a follow-up on Guadalajara and Monterrey. Is it a possibility of having lower prices in the future a potential strategy to face a more fierce competition? And do -- isn't there any entry barriers in both markets that could prevent further competition to be more aggressive in the future?

[Hector Ibarzabal, executive]

Thank you for your question, Cecilia. What is happening in Guadalajara is the markets in which we have 80% of our holdings are very well located in central market. And for those types of market, there is a barrier of entry, and that's why we feel confident that for those markets, we will keep on with our occupancy and we will keep on pushing rents. There is a new corridor where there's a lot of land available, and it is there where new institutional investors have been starting construction. I think that this will have 2 consequences. One of them is that as the market keeps on growing, that's the only corridor where they will have the opportunity to have a space. So eventually, this corridor is going to get traction. But the rents that these corridors are going to get are lower than the infill rents, which is where the main part of our portfolio is. We are ready to compete in both corridors. And on the overall, we think that we will have the ability to keep on pushing rents in Monterrey even with this environment -- in Guadalajara, I meant. In Monterrey, the situation is different. 100% of our holdings are in Apodaca. Apodaca is the most active and the best market that Monterrey has. It's a market where there's barriers of entrants. I think that our profile of customers in Monterrey and the way we are positioned with our product and service will keep on -- allow us to see rent growth as well in Monterrey. So even though -- when we classify our markets, we need to classify Monterrey and Guadalajara this time as not the strongest markets that we have, we'll keep on being positive about the combination that we have between our product, our service and our quality. And we don't see a major operational turndown, not even in these 2 markets.

[Operator]

Your next question comes from the line of Marimar Torreblanca from UBS.

[Marimar Torreblanca, analyst]

My question is going back to the acquisitions that you are seeing for this year. Can you give us a bit of color on what level of cap rates or what price per square meter you're seeing in the different markets that you're planning to acquire assets from?

[Luis Gutierrez, executive]

Marimar, this is Luis, and thank you very much for your question. So yes, if you look at the Prologis pipeline, which is where we believe it's going to be the major acquisition guidance, it's about 5.1 million square feet. About 3.5 million of those comes from Mexico City, 0.5 million from Guadalajara, 0.9 million from Monterrey and 0.2 million from Juarez. So as you know, the values will be market values, so we expect cap rate in Mexico City to be around 7%; Guadalajara, somewhere between 7.25% and 7.5%; Monterrey, as Guadalajara, maybe between 7.25% and 7.5%; and Juarez, between 7.75% and 8%.

[Operator]

Your next question comes from the line of Francisco Chavez from BBVA.

[Francisco Chávez Martínez, analyst]

I have 2 questions. The first one is regarding the EBITDA and AFFO margins that increased significantly in 1Q, how sustainable are these margins? And the second question is regarding the payout that we saw in the first Q, which according to my numbers, was below 90%. Do you expect to continue with this kind of payout? Or can we see a normalization to the 100% in the coming months?

[Jorge Girault, executive]

[Foreign Language] Francisco, this is Jorge. I'm going to answer first your question on the payout. The payout ratio is going to be closer to 95%. You have to see it on an annual basis. It can vary quarter-to-quarter. But as you have seen in our previous dispositions, our ratio has been floating around 95%. It has been 94%, 96% or 95%. I mean, it has been moving around that number. But you will see something closer to 95% during the year. Regarding the EBITDA levels, yes, these levels were increased this year basically because of our increase in the rents, as you saw in our NOI, and reduction on the expense line due to some bad debt recuperations that we did as well as a reduction on the interest expense. The EBITDA level, you will see it more in the 77%, 76% margin as you have seen previously. This quarter was higher, 79%. But on an annual basis, you will see something closer to 75%.

[Operator]

[Operator Instructions] Your next question comes from the line of Sheila McGrath from Evercore.

[Sheila McGrath, analyst]

Yes. I just had a question on your comments on the lack -- the undersupply of modern logistics space in Mexico City. Is there an element of existing stock that's functionally obsolete kind of not captured in market reports? And is this mostly driven by size? Do the e-commerce tenants require 1 million square feet and the other buildings are too small? Just if you could give us a little color on that and also how much land your sponsor controls in Mexico City to continue to develop this logistics space for e-commerce.

[Hector Ibarzabal, executive]

Sheila, thank you. Thank you for your question. And basically, the market is in such a good shape in Mexico City that even obsolete space is getting acceptance from different type of customers. The fact that e-commerce are trying to target larger facilities is because of this, they gain important efficiencies. And I think that we are very well positioned because we have been the only ones -- competition now is following on that, on providing or trying to do larger buildings. So the small, obsolete buildings are occupied as well. We are seeing some demand for last-mile spaces, which in a city like Mexico, are very difficult to provide. We're currently analyzing that possibility through our sponsor, Prologis. And we have, as you know, in the U.S. and in some other markets like Japan, there has been multistory developments. I'm not suggesting that we are there, but if rents keep on increasing, I think that eventually, Mexico City market will be offering the possibility of doing multistory development. What we have seen is that the most of developers now are targeting north of the tollbooth because it is there where land could be found. And we have seen major retailers already doing important investments on that corridor, and that corridor is something as well that Prologis, our sponsor, is analyzing. In Mexico City, currently, we have 27 hectares of land. That's all we have. We are analyzing what is the best solution for the land that we have in Mexico, in Mexico City. But definitely, our sponsor, Prologis, is actively chasing new land opportunities in Mexico to take advantage of these e-commerce trends that we see will keep on creating important demand in the midterm.

[Operator]

Your next question comes from the line of Alan Macias from Merrill Lynch.

[Alan Macias, analyst]

Just a clarification on your debt. What percentage is fixed rate, including the hedging? And if your cost of debt that you mentioned is -- includes the hedging cost?

[Jorge Girault, executive]

[Foreign Language] Alan. This is Jorge. To answer the second part of your question, yes, the cost of 4.2% includes the hedge -- the swap, sorry, that we put in place. 98% of our debt right now is fixed, as we have -- regard to line of credit. As we buy assets and we do acquisitions and we use the line of credit, you will see the percentage of flowing rate increase because of that nature. But right now, most of our debt is fixed.

[Operator]

We have no further questions in the queue at this time. Luis Gutierrez, I will turn the call back over to you for closing remarks.

[Luis Gutierrez, executive]

Well, thank you very much, and I would like to thank everyone that's on the call for their interest in FIBRA Prologis. We had a great beginning of the year. And in spite of geopolitical issues, we feel it's going to be a strong year. So I encourage you to contact us and maybe schedule a visit for Mexico City to visit Grande. The -- our sponsor is finalizing the million square footer, and it will be interesting to visit that. So thank you very much, and looking forward to see you soon.

[Operator]

This concludes today's conference call. Thank you for your participation, and you may now disconnect.