Prologis Property Mexico SA de CV

OTC:FBBPF

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. My name is David, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the FIBRA Prologis First Quarter Earnings Conference Call. Today's conference is being recorded. [Operator Instructions]

Alexandra Violante, Head of Investor Relations, you may begin your conference.

[Alexandra Violante, executive]

Thank you, David, and good morning, everyone. Welcome to our first quarter 2023 earnings conference call. Before we begin our prepared remarks, I would like to remind everyone that all information presented in this conference call is proprietary and all rights are reserved. The information has been prepared only for information purposes and is not a solicitation of an offer to buy or sell any securities.

Forward-looking statements during this call speak only as of the date of this call. Our actual results, performance, prospects or opportunities may differ materially from those expressed in or implied by the forward-looking statements. Additionally, during this call, we may refer to certain nonaccounting financial measures. The company does not assume any obligations to update or revise any of these forward-looking statements in the future, whether of a result of new information, future events or otherwise, except as required by law.

As is our practice, we had prepared supplementary materials that we may reference during the call as well. If you have not already done so, I will encourage you to visit our website at fibraprologis.com and download this material. 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. Also joining us today is Hector Ibarzabal, our Managing Director; and Alejandro Chavelas, our Head of Valuations and Research.

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

[Luis Gutierrez, executive]

Thank you, Ali, and good morning, everyone. 2023 has started on a strong note, which is reflected in our operational and financial results above expectations, providing us confidence in our outlook for the year. Therefore, we are adjusting our guidance and Jorge will provide more color on this.

Let me give you some highlights. FFO and AFFO had the highest growth since IPO in 2014 above 20%. Occupancy remains above 98%, reflecting favorable market conditions and the quality of our portfolio. We had a strong cash flow generation reflected in the same-store cash NOI mainly due to record rental growth on rollover of 38.5%. On the ESG front and one of our milestones is to provide clean energy to our customers. I would like to announce that we expect to install solar panels in around 120 buildings in the next 12 to 24 months.

Industrial fundamentals remain solid. Demand has more than doubled since 2020, and we expect a better year in 2023, mainly due to the assuring. We think this trend is durable for years to come. This is caused by a structural shift in supply chains as companies are making strategic decisions to relocate their manufacturing operations. These junctures come in cycles of 15 to 20 years. Demand in the first quarter is at high levels. Net absorption in our 6 market was a record 12.1 million square feet, representing a 44% increase against the first quarter of 2022. This is mainly driven by leasing activity from companies that are growing their presence in the country.

On the back of this, our updated forecast points to a similar level of absorption in 2023 to last year's. We believe the main restriction for further growth will be a scarcity on title land, limited by energy and permitting restrictions. While the construction pipeline has increased materially in some markets, 60% of it is already preleased, indicating supply tightness may continue. Vacancy in our market is one of the lowest at 1.1% with broader markets still solid sold out.

Rents remain an upward trajectory, rising 4% sequentially and 20% year-over-year. We expect rents to continue increasing throughout the year as replacement costs are still rising and also in light of a very low availability of high-quality products.

Let me expand on what we're seeing on the ground. [indiscernible] projects have reached a record of 60% of all construction. Clients are bidding aggressively for space with some willing to provide concessions such as advanced payments and earlier preleasing to security. On the manufacturing side, Monterrey has been the major winner by tripling its net absorption in the quarter compared to pre-covered levels, while border markets have doubled. Without a doubt, net absorption could be higher, but there are multiple challenges in delivering new space.

The main sectors that stand out are: first, the auto sector as OEMs are changing their production lines to electric vehicles. And as a result, we have been seen the Tesla announcement. And secondly, the electronics sector, we are seeing some major hubs being built in different markets. In the quarter, most of the larger transactions were undertaken by companies in inventory management services for manufacturing. We believe these capacity additions are a leading indicator of further near-shoring activity in the country.

Our sponsor has leased 4 new buildings in [indiscernible] and is in the process of closing an additional one, representing 1.7 million square feet of new space, and all of these are related to what I just talked about, inventory management services for manufacturing. On the logistics side, and in addition to the good news on the manufacturing, Mexico City, which is the most consumption-oriented market saw a significant decline in vacancy as demand remains elevated and construction levels are insufficient. In this market, demand has outpaced supply for the last 6 quarters, a trend that we expect to continue during the year, driving rental growth acceleration and development is starting after the total.

In addition, the big e-com companies are working to secure the spaces and our sponsor has a land bank that is attractive for them. They are currently under discussions. Logistics real estate continues to be a favorite asset class among investors, and FIBRA Prologis is well positioned to outperform. Despite higher interest rates and marginal cap rate expansions, valuations came flat for the quarter that were offset by rental growth. Mexican real estate remains resilient in comparison to other markets around the world and the gap between cap rates has narrowed, given the local investor interest and market fundamentals in our country.

In summary, we are more optimistic of 2023's outlook. On the internal growth side, raising rents to market is the main source of value generation. Our mark-to-market increased 320 basis points quarter-over-quarter to 23.7%. We will continue to push rents and term. On the external front, our capital deployment plan is now to invest up to $450 million. This will mainly come from our sponsor development pipeline, which is currently at 5.3 million square feet. These assets are well located and no other competitor has access to anything remotely close to the size and quality. And in addition, we will keep exploring third-party assets that align with our investment strategy.

Our balance sheet is the best in the sector and one of our biggest competitive advantages. We have enough firepower to be opportunistic and act quickly. Also, I would like to thank our team, which continue proving themselves as the best in class and have been able to deliver outstanding results. Finally, we remain committed to our shareholders and putting their interest first.

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

[Jorge Girault, executive]

Thank you, Luis. Good morning, and thank you for joining us. During this last quarter, FIBRA Prologis delivered higher-than-expected results, driven by strong rain change and rollover followed by annual bumps and strong FX. We also have the most competitive cost of debt in the industry and one of the lowest loan to values, which gives us an important advantage in this environment.

With this, let me turn to the results for the period. FFO and AFFO reached $48 million and $40 million, respectively, both representing a 21% increase versus last year and above our expectations. Moving to operating metrics. Leasing activity reached 1.4 million square feet with a period end and average occupancy each at 98.4%, in line with previous quarters. Net effective rent change and rollover increased 38.5%, representing the highest in PO a new record. For the last 12 months, it has been above 26%. In terms of same-store cash and GAAP NOI, we had a positive increase of 10.4% and 9%, respectively.

Let me now turn to our balance sheet. Since IPO, we have been clear on our goals from a financing perspective to have a strong and flexible balance sheet. To accomplish this, we have been patient and opportunistic, taking advantage of windows that have benefited the refinancing of our debt. We also have a well-thought strategy, among other things, we try avoiding large columns of debt maturities that could be hard to refinance in event of a financial crisis like the GFC or recent volatility. In short, we have learned from the past.

Today, we have a balance sheet that gives us a competitive advantage in our sector. It's the difference between having a good company and a great company, providing flexibility that supports our teams in creating value to our shareholders. For example, the fact that we don't have to refinance in this environment, which will only undermine our cash flow generation is a result of a well-thought strategy. To have -- to give you some perspective, our average debt maturity is 7.3 years, and we don't have any short-term debt terminations. 100% of our debt is fixed at a weighted average cost of 4%. 81% of our debt is unsecured and more than 58% is green, loan-to-values below 21%. Our ratio of fixed coverage and debt to adjusted EBITDA are at healthy levels of 6% and 3.6%, respectively. To be a great real estate company, it's not only about managing the portfolio with excellence. We also need to excel in our risk and balance sheet management. This combination makes us one of a kind standing out in our sector.

Turning to guidance. Given this quarter results, we are updating part of our guidance for the year. Following our strong leasing and record rate change, we expect same-store cash NOI growth to be between 5.5% and 7.5%. On the capital deployment front, we expect to acquire between $250 million and $450 million. Putting all these together, we are setting our full year FFO per CBFI range between $0.18 and $0.19.

Moving to ESG. We have been upgraded on the MSCI ESG to A from BBB. Our solar initiative pilot program has given good results. And as we mentioned, we are making progress to expand it. The idea is to allow us to meet our net zero goal by 2040, Scope 3. We also obtained a GOL certification on the BOMA based standards. This recognition is the first of its kind in Latin America for an industrial building.

I would like to finish thanking our teams on the ground who have made an excellent job and our stakeholders for their constant trust and support. We are committed to deliver sustainable growth and given our unique position in the sector; we have optionality to capture future value.

With this, I turn it back to David for Q&A.

[Operator]

[Operator Instructions] We'll take our first question from Vanessa Quiroga with Credit Suisse.

[Vanessa Quiroga, analyst]

Congrats on the results. The question that I have is regarding M&A and yes, how you are seeing the environment for M&A right now? Is there a match between prices that want to be paid versus prices that sellers want to receive. And if you see that FIBRA Prologis can be a key player in the current M&A opportunities in Mexico.

[Luis Gutierrez, executive]

Vanessa, and thank you for being on the call. Well, certainly, FIBRA is greatly positioned to take care of any opportunities that the current environment may arise. So at this time, we have been seeing that after a very turbulent end of last year with higher interest rates, we have been seeing price discovery, and we feel comfortable that the market has reached a level. We have also seen a more active investment market, and we believe that there will be some other portfolios and opportunities may arise before the end of the year. And I think we're very well positioned to take advantage of anything that comes our way. And this is one of the reasons why we have upgraded our acquisition pipeline, our acquisition guidance.

[Operator]

Next, we'll go to Gerard [indiscernible] with Goldman Sachs.

[Unknown Analyst]

So I just wanted to talk on 2 things. One on your net effective leasing spreads and your same-store cash NOI guidance. So first off, on your net effective lease spread, so you hit a record level near 40%. And I've asked this in previous calls, but I'm just curious, how much more do you think this can go? I mean when you start looking at, for example, Polaris REIT in the U.S., they hit near 70% in this past quarter. Is it -- can we see these net effective leasing spreads going higher as we see the tightness continue in your key markets?

And then the second question is around same-store cash NOI. So it hit 10.4% this quarter, but the midpoint of your guidance is 6.5%. So I was wondering if you can comment a little bit about what -- if you expect a deceleration from the levels we hit in 1Q? Or is this because of tougher comps? If you could provide any color on that, that would be helpful.

[Luis Gutierrez, executive]

Thank you very much, Gerard. I will answer the first part of your question regarding rent spreads. Actually, the way we have been operating on the field is taking us to a position in which we have been improving our debt and rent change every quarter. This has a bit of frictional [indiscernible] -- this quarter, for example, the market in which we have the most leasing activity was Mexico City. And it was exactly that market, the one that we presented, one of the highest rate change with 39.2%. We do expect market trends to keep increasing due to the challenge that supply in space exists in all of our markets. And we think that by year-end, we will have close to the current market change that we're presenting is not going to be as high as in the U.S., but it's going to be a record number for 2023.

[Jorge Girault, executive]

And Gerard, this is Jorge. Regarding your question on same-store and the midpoint of our guidance. I mean same-store cash NOI is affected by basically 3 things. when it ran change, and Peter just commented on that on the same-store pool. The other one is occupancy and the other one is FX. You see our occupancy for guidance is between 97% and 98%, midpoint 97.5%, a little bit below what we have today. I mean, we are adjusting to that in our guidance. And also on FX, we have 1/3 of our revenues in pesos. So we do adjust on different FX for that, and that's the reason why we have that spread. I mean we also revised this every quarter. And typically, we see the FX more stable for the 2/3 of the year in the third quarter, we sometimes do some adjustments there. But who knows where FX will be at the end of the year.

[Operator]

Next, we'll go to Juan Ponce, Bradesco BBI.

[Juan Ponce, analyst]

What are the biggest constraints on the supply side? I mean, clearly, demand is pretty strong. Nearshoring, you spoke a lot about it. But what are you seeing more on the ground in terms of the supply?

[Luis Gutierrez, executive]

Thank you, Juan, for your question. I have expressed several times that you don't have the infrastructure in place to take care of the nearshore opportunities, probably the activity that nearshoring would be presented could be above 3x what we are experiencing. We have a very strong pipeline, particularly in all of our 3 markets and Monterrey. And some of these requirements are not in the position to be sold because -- mainly because of the lack of electricity. Electricity is becoming an issue that you need to start working in advance, in some cases, 24 to 30 months in advance. And we're starting to see in some markets like Tijuana, some issues regarding water supply, Montreal in this category.

On top of this lack of infrastructure, the interment process that in the old days used to be smooth and fast. [indiscernible] process is becoming more difficult. I think that authorities are raising the bark concerning all the infrastructure investments that you need to do in order to be able to launch a new park. And the main point about this situation is I do not see any of these 2 conditions to be solved anytime soon. Infrastructure thing requires a lot of changes to the current approach that we have, and it reports a lot of time in order to be to in place. And the entire process is something that we can improve, but permits are local, so you need to deal with a bunch of different authorities that in most of the cases, they want higher requirements than what are reasonable for the process.

[Operator]

Next, we'll go to Pablo Monsivais with Barclays.

[Pablo Monsivais, analyst]

My question is regarding keeping in mind the environment and the very strong demand that you're seeing, is the current model of FIBRA Prologis and Prologis U.S. in Mexico, the best way to tackle the opportunities? Do you think there is perhaps in the long term, an opportunity to perhaps merge the 2 companies or to make a single entity capable of developing faster. And I know that the CapEx plans on the Prologis U.S. and Mexico are longer term. But I think that the demand is strong enough to sustain that. What are your thoughts?

[Luis Gutierrez, executive]

Thank you Pablo, for your question. So what you are talking about is that FIBRA develops. I think we have been very clear in our strategy. And I think the setup we have is the best one. Through time, you have been seeing that normally, the development is not valued in public real estate companies around the world. And we believe FIBRA Prologis is a company that provides a stable cash flow and to the -- and mainly operating assets and does not participate in the development risk. We like this profile. And I don't think that would be wise to change it. We also think that on the capital that is required to -- it's much better to have it in stabilized properties than to have it in the development business. So I think our setup is very well to take advantage of these opportunities.

[Jorge Girault, executive]

Just an additional color to this last comment, Luis. Prologis sponsor has currently above $500 million invested on the development pipeline and on the land that Prologis has under control. And this is a game which Prologis might be increasing this figure probably by USD 200 million or USD 300 million. So if you load with 800 million of unproductive assets to FIBRA, the operating metrics, which is one of the biggest products that we have could be -- are going to be damaged. Are different risks, as Luis mentioned, so do not expect any change in this regard an intention.

[Operator]

Next, we'll go to Alan Macias with Bank of America.

[Alan Macias, analyst]

Just one question. You haven't completed acquisitions year-to-date. I just wanted to see if you can remind us of the conditions -- the market conditions that, I guess, were not favorable to complete the acquisitions. And what has changed and if these conditions have changed, and in order for you to complete the acquisitions.

[Jorge Girault, executive]

Thank you, Alan, for your question. And certainly, as you have been seeing and as I have said, we have been increasing our guidance to $450 million. At the beginning of the year, we had a view, but with the increase in interest rates, we saw some value declines in other markets. The Mexican real estate has remained resilient and mainly our values have come flat. But we needed to see that the market was stabilizing. I think now after 6 months, we feel very comfortable and we've seen price discovery, and we're ready to move forward.

Around $350 million of our acquisition will come from the Prologis pipeline, and we will act on in the second half of the year. In terms of pricing, I think we will buy at market and given the differences in rents because of the high rental growth, we always check the IRR of the projects and FIBRA will acquire properties that will at least meet a 9% threshold IRR 0.4.

[Luis Gutierrez, executive]

On the third-party acquisitions, it's very difficult to have a forecast because sometimes we have visibility of portfolios that's going to be out in the market, but sometimes we don't. So we don't want to feel force if we are not doing the right acquisitions of the right quality real estate at the right price in the right markets.

To the current visibility that we have, we think that we are going to be more active than what is expected on third-party acquisitions. And this is something that is going to be happening as well in the second part of 2023.

[Operator]

We'll move to our next question, Gabriel Himelfarb with Scotia.

[Gabriel Himelfarb Mustri, analyst]

I think for the call, a quick question for modeling purposes on your new guidance and acquisitions. Is it fair to assume that all funding cost near the 5.5% mark and to model cap rates for the targeted assets at 6.5%. Any color on the timing to deployment of these investments?

[Jorge Girault, executive]

Gabriel, this is Jorge. You -- it was hard a little bit to hear you. One of your questions was modeling cap rate of 6% and the other one, the 5.5% was for debt. Is that tight, correct?

[Gabriel Himelfarb Mustri, analyst]

In funding costs, is it fair to model in that way?

[Jorge Girault, executive]

On the debt side, I would say, yes. Remember that we have a line of credit. We're in the process of recasting the line of credit. We are going into good process right now. Currently, the line of credit is at 200 basis points over SOFR, and we have some cash available. So I mean, you can do the math. On the modeling cap rate.

[Luis Gutierrez, executive]

Yes, on the modeling cap rate, as I said, Gabriel, FIBRA acquires at market. And if you see our appraisal is around 7%. And if you look at the markets, some of them will trade below 7%. Some of them will trade above 7%, but the appraisal cap rate just gives you a very good sense of where the market is and the pricing that we will acquire these properties [indiscernible] in the second half.

[Operator]

Next, we'll move to our next question, Felipe Barragan with BTG Pactual.

[Felipe Barragan, analyst]

Congrats on the results. I have a couple of questions. One is on the balance sheet. So you had noted that you guys have a really strong balance sheet, which is true. And I was just wondering with considering the acquisitions that you might have in the second half of this year, what is a comfortable LTV that you guys feel comfortable in perhaps expanding to take advantage of the opportunities? And my second question is more on a little bit more color on the decreases in occupancy rates for Guadalajara and the party that we saw sequentially this quarter.

[Jorge Girault, executive]

Felipe. Thank you for the question. This is Jorge. And just in case, Gabriel's question wasn't -- the second part of the question wasn't heard. The acquisitions are meant to be in the second half of the year. We've mentioned that, but I think it was at the end of the conversation. On your question Felipe the balance sheet, yes, we have below 21%. We are comfortable -- our internal threshold is 35% loan-to-value. That's about $800 million of additional debt. We don't want to be in those levels. I think that we will be between 25% and 30% at the most.

[Luis Gutierrez, executive]

On the termination regions for our customers, we had 429,000 square feet on 5 different cases. 2 of the situations that left our space is because we didn't have additional space to keep their needs, so we need to want to look for someone else. And the other 3 ones are related to consolidation or company buy-out situations. There is no reason I don't have any particular concern that any of our markets are experiencing a negative trend on occupancy or rent on the contrary. We have in our markets 1.1% vacancy on the overall and the challenge that the markets are facing, as I commented in the previous question is the lack of ability to supply the space. Because of this, market trends will keep on growing, and we should expect organic growth for FIBRA in this regard.

[Operator]

Next we will go to Juan Macedo GBM.

[Juan Macedo, analyst]

My question is regarding the [ tenant improvements ], we saw less than initial during the quarter. And I was just wondering if you could provide some color on this. Additionally, if you could share your thoughts on future dynamics, we are trying to understand if maybe mention new sharing to bring more specialized tenants that could require higher investments.

[Jorge Girault, executive]

Juan, sorry, this is our Jorge. I didn't -- we didn't hear your first question. Can you repeat it?

[Juan Macedo, analyst]

My first question is regarding lower tenant improvements during the quarter. If you could provide us some color on this? And the second question is regarding future dynamics. We are trying to understand if measuring demand could bring more specialized tenants that could require higher investments in tenant improvements.

[Jorge Girault, executive]

Thank you, Juan, for your question. lower TIs, I think that is a reflect of a market trend. The same way you are in a position to increase rents. You can have better negotiations for FIBRA Prologis regarding the amount of money that you need to spend in tenant improvements. So I think that this is a trend of how markets are getting with very low vacancy.

The second part of your question regarding what we should expect from the pipeline from your shoring. Effectively, I would like to mention 2 highlight points. The first one is that we are seeing an increase on logistics activities in the border markets and in Monterrey. These are logistics regarding business-to-business, which is someone that in the past, the manufacturing companies used to take care inside their own facilities as they are expanding their manufacturing footprint, they are using third-party logistics specialized, not to bring the Amazon box to your house, but to drink all the components in the manufacturing lines according to what we expected.

We do see as well some customers that are requiring high energy and is in this high energy consumption and is in this specific point where not only Prologis but the market in the overall is facing difficulties because some of these cases, you need to take the decision whether to entertain the needs of a high consumer electricity customer or go with some customers that is going to request less energy. And the answer to this question is obvious. So once again, we go back to the point of the lack of infrastructure. That's something that we are working. And Luis mentioned in his opening remarks that by the end of this year, we will have 160 of our buildings already with solar pines, which I think is going to be a bigger step towards improving in these important at.

[Operator]

Next, we'll go to Andre Mazini with Citigroup.

[André Mazini, analyst]

Two quick ones. The first one on dividend and payout. So a lot of dividends were paid in the fourth Q, right, even more than the FFO. So what's the rationale for kind of strong loading payments in the first half of the year. What you said that acquisitions are going to be in the second part of the year, so more dividend in the first half and then acquisitions in the second half of the year? Does that rationale make sense? And the second one, a quick one on acquisitions. How do you guys feel about maybe sale leaseback due to [indiscernible] I understand the market is very hot, which diminishes a lot the spec buildings, right, because lease-up surpass so and so forth. But is there an opportunity as well in the -- for instance, in the sales leaseback space, which is not something that common, right? I think with free in general.

[Jorge Girault, executive]

Andre. Good to hear you. This is Jorge. Regarding your question on the dividend and as we disclosed on the fourth quarter call and results, given the way that the taxable income is calculated in Mexico because of the tax rules and the rules that FIBRA have a low FX and high inflation add up to this taxable income. So we have to distribute and we did on March 10, we distributed $45 million given this additional distribution from a tax perspective. So that covers 2022 taxable income. But it's part this $47 million and part of the guidance that we give for 2023. So we -- you won't see another payment -- dividend payment for the first quarter that has already done, March 10. And then you will see second, third and fourth quarter. We are complying with the local role. And in all, in an annual basis, what you will see on your dividend payout is a 90% AFFO payout rate.

[Luis Gutierrez, executive]

And Andre in your second question on the profile of the acquisitions. I would say that talking about the Prologis pipeline, a huge percentage of it is build-to-suit given the how tight the market is in the low vacancy. And of course, FIBRA is well positioned to have exclusive on this pipeline. So a lot of build-to-suits. And of course, the parent, the sponsor will also be putting additional space for spec buildings in markets that do make sense. So we will have a combination of both. As to sale and leasebacks, we are seeing some opportunities in this field, but they're not the majority of it. Most of them are build suit and spec buildings.

[Operator]

Next, we'll go to a follow-up question from Gabriel Himelfarb with Scotiabank.

[Gabriel Himelfarb Mustri, analyst]

Just a quick follow-up question. We noticed that PLD didn't make any deployment starts in this year -- in this quarter in Mexico and yet it still has lots of land reserves. Do you expect development starts to resume in Mexico or in the rest of the year or in the in which market in Mexico?

[Luis Gutierrez, executive]

Thank you, Gabriel. And yes, of course, and this is just a timing issue. I think you need to analyze this on different quarters. So we are seeing a strong pipeline. The sponsor will put projects to work before the end of the year, and we're expecting at least around between $200 million and $300 million of new product during the second quarter and the second half of the year.

[Jorge Girault, executive]

Important to highlight that PLD has no restrictions to invest in Mexico and the near-shoring engine on the [indiscernible] in Mexico as one of the attractive markets that DLB has to [indiscernible] capital. So it's just sometimes the tills take time and could be a quarter with no activity you will see plenty of activity.

[Operator]

[Operator Instructions] Okay. Showing no further questions at this time. I'll now turn the call back over to Luis Gutierrez, CEO, for any additional or closing remarks.

[Luis Gutierrez, executive]

Well, I just want to thank everyone for their interest and the participating in this call. This has been a really great start of the year. We have been seeing a great market and FIBRA Prologis is very well positioned to outperform. So thank you, and looking forward to seeing you either in a visit or on the next quarter call. Thank you.

[Operator]

And this does conclude today's conference call. You may now disconnect.