Prologis Property Mexico SA de CV
OTC:FBBPF
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Prologis Property Mexico SA de CV
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Good morning. My name is Marissa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the FIBRA Prologis Quarterly Earnings Call. [Operator Instructions] Mr. Karmaniolas, you may begin the conference.
Thank you, Marissa, and good morning, everyone. Thank you for joining us for our third quarter 2018 earnings conference call.
Today, we will hear from Luis Gutiérrez, 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.
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 have prepared supplementary materials that we may reference during this call as well. If you have not already 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.
Thank you, Kosta, and good morning, everyone. Our customers are active and moving ahead with their business plans, which in turn, has propelled FIBRA Prologis momentum, this resulting in a great third quarter.
We leased 3 million square feet, increasing occupancy to 96.5%. Our portfolio has been above 95% in the last 16 quarters. Rent change on rollover exceeded 10% for the 6th straight quarter.
Looking at what FIBRA Prologis has accomplished year-to-date. FFO for the first 9 months of the year increased 3% compared to the first 9 months of last year, while AFFO was higher by 8% over the same periods.
Before discussing the operating environment, let me spend a few moments on 2 key events from the third quarter. First, Mexico's new President will take office in a little more than a month. While not all facets of his platform are known, his policies and appointments to date appear to favor consumption and free trade, which are a driver of our business.
Second, there is a developing clarity on U.S. trade relations following the announcement of the U.S.-Mexico-Canada agreement, or USMCA. This has had a positive impact on manufacturers already doing business in Mexico. We're already experiencing an increase in existing customer activity, and importantly, new entrants that had been on the sidelines during the NAFTA renegotiations are becoming active.
For example, in Tijuana, we have seen an influx of Chinese and Korean electronics manufacturers who already are actively looking for space. One of our customers in the medical device industry is expanding their campus there.
A Taiwanese multinational electronics manufacturer in the final stages of signing a deal with our sponsor in Juarez, in a building that in turn will be offered to FIBRA Prologis.
In addition, the operating environment remains healthy. In the third quarter, market vacancy remained low at 4.5%. In certain markets, the lack of available space has been a governor on absorption, as evidenced by the 1.2 million square feet imbalance in the third quarter. Despite the rising supply in certain markets, we still expect to see market rental growth of 3%.
Scarcity of available product continued to be a theme in Mexico City, as evidenced by market vacancy of just over 1% for modern, well-located products such as the buildings in our portfolio. Market rents there have been rising, and customers have reacted by locking into longer-term leases.
Vacancies in our markets at the border were 4.1%. After Mexico City, we see the strongest market rental growth in Tijuana, Reynosa and Ciudad Juarez. With USMCA clarifying trade relations, demands should increase, and we believe our portfolio would disproportionally benefit.
Now let me update you on Guadalajara and Monterrey. Demand for our product in Monterrey remains strong, as evidenced by our occupancy, beating the market by 350 basis points. In Guadalajara, new supply isn't backing the equilibrium. However, this quarter, we did see an improvement in market vacancy of 100 basis points to 5%. Bottom line, the operating environment is favorable to continued market rental growth, which will drive NOI higher.
Before concluding, let me discuss why we are well positioned to continue to outperform and deliver the positive results. Mexican employment is the highest it has ever been. Retail sales were higher than expected and consumer confidence recorded the strongest month-over-month change on record following the election in July. This translates favorably for FIBRA Prologis as our portfolio is overweight consumption and we own the best real estate in the sector.
Manufacturing remains solid and its outlook has only improved following the USMCA announcement. Our portfolio in the border markets is second to none, and we expect to benefit disproportionately.
E-commerce is in its infancy in Mexico, and we expect it will have a significant positive impact on our business given the space requirements versus a traditional distribution center. We have excellent embedded earnings potential from the gap between our in-place and market rents, which we will capture at lease expiration.
And finally, we have a well-positioned balance sheet with low leverage and plenty of liquidity. 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 agreed manner.
With that, let me turn the call over to Jorge to go through the numbers.
Thank you, Luis. Good morning, and thank you for joining our third quarter 2019 earnings call. Starting with operations. As Luis mentioned, quarter end occupancy was 96.5%, an increase of 60 basis points from the second quarter and 10 basis points from the same period last year.
Leasing volume was the highest in the year, with Mexico City and Guadalajara, representing 60%. Renewal represented 82%, further evidence of the quality of our portfolio and our superior service. As we talked previously, we are focused on increasing rents and expanding lease terms, which have been evident in our results for the past several quarters.
Net effective rent change on rollover increased by 10.6% in dollar terms. Rent change was led by Mexico City and Ciudad Juarez. And in 4 of our 6 markets, we're up over 10%.
It's important to point out that FIBRA Prologis portfolio is 5% below market rent. Let me pause here for a second. The 5% gap is a comparison between average market rents and in-place rents. About 20% of the portfolio rose this year and recent expirations have had larger gap versus market, as shown by our double-digit rent change. Higher rent and contractual rent bumps were muted by weaker peso and more free rent due to longer lease terms. As a result, our cash same-store NOI increased by 1.7%.
The increase in free rent is function of term, which has been longer than our expectations, and not an indication that concessions are rising.
Now let me move to our financial performance. FFO came in at $25.9 million, a decline of 4.2% compared with the third quarter last year. This impact was mainly due to non-cash reclassification on straight-lined rent from the second quarter that was reversed this quarter. Our 9 months results evens out this adjustment, showing a 3.4% increase on FFO if compared to same period last year.
As a result, AFFO was flat if compared to the third quarter of last year at $21.9 million and had an 8.2% increase compared to the 9-month period as we balance out the reclassification previously mentioned.
Now let me move to our balance sheet. As I have said in previous quarters, I am proud of the balance sheet strength. We have significant liquidity, low leverage, level maturities, and we have mitigated our FX risk. The result is one of the strongest balance sheet in the sector.
Currently, we're looking at expanding our near debt maturities, which will result in an even lower risk balance sheet. With our expectations of future rate increases, we need to take advantage of current rates. We will keep you posted of progress we've made.
Let me now update you on our annual guidance. We're adjusting our same-store cash NOI range due to weaker peso and higher concession as a result of longer lease terms. The new range for full year is between 3% and 4%. We are maintaining our FFO per certificates range, which excludes any impact of the incentive fees paid to our sponsors. Including the impact of incentive fees and associated certificates, FFO is expected to be between $0.15 and $0.16 per CBFI. Please go to Page 7 of the supplemental financial information to see the full detail of our 2018 guidance.
FIBRA Prologis results for the first 9 months of the year were excellent. Our business has proven to be in great operational and financial shape, thanks to our focused strategy and prudent risk management approach, executed by our outstanding team. We're strongly focused on customer satisfaction as well as delivering the best results possible to our certificate holders.
With that, I will turn it over to the operator for the Q&A.
[Operator Instructions] Your first question comes from the line of Sheila McGrath with Evercore.
I just wanted to understand a little bit more about the tenants wanting longer lease term and your view. I would think this would be a positive. I'm just wondering your view of why the tenants want the longer lease term and if this is a benefit.
Sheila, this is Hector. Actually, I would say that it's Prologis's strategy to try to push term -- to push longer terms. We think that we're in a great moment of the cycle. We want to take advantage of this. We do a serious analysis every time that we're doing a new lease or a renewal. We understand our tenant capabilities. And with a full-year strategy, we try to do that -- to date as long-term as possible. Sometimes, we try to push rents. Today the moment in which we are in the cycle, we think that having longer terms would eventually take us to a position in which we will be better off if eventually 2 or 3 years a potential change in the cycle could happen. I'm very proud of what the job my teams have done in the field of reaching this objective, and this time, we will keep on with this strategy at least for 2019.
In addition, Sheila, market vacancy has been very, very low in Mexico City, reaching 1%. And certainly, tenants, which are -- have a view of the market, they want to lock their spaces as rents for sure will go up and the clients are trying to secure the space for a longer period of time.
Your next question comes from the line of Victor Tapia with Bradesco.
So just a quick question here. After the conclusion of the NAFTA negotiations, now the USMCA, you had said you guys are expecting increased leasing activity. The Chinese are looking for some buildings to lease. But can you give a little bit more of color on how you are seeing the competition increasing given that. And some, I don't know, increasing vacancies or pressure on rent price?
So thank you very much for your question. So yes, I think the signing of this agreement has been very positive. First of all, it introduces certainty to the Mexico trade relation and the fact that the U.S. will not pull out of this agreement. So this will bring a lot of tranquility for the financial markets and more stability to the FX and other ratios. We have seen demand being very resilient from companies that mainly do business in Mexico and, given the strong U.S. economy, they continue to expand because there is demand for those products. And now, let me turn the call over to Hector so that he can explain the specific trends in each one of our markets and comment on the competitor status.
Yes. I think that the business that we have in the border is going to be benefited by this definition of USMCA. The activity we have been mentioning in previous calls did not slow down because of the uncertainty, but it is a fact that new companies that regularly were looking for Mexico to [ centralize ] operations, they've put on hold their plans. This uncertainty is left behind, and we do expect in the short and medium term those companies to start landing some projects in our border. I think that the border is very well positioned. Some of the incentives that [ Ando ] has been describing -- are going to be happening in the border, are going to be benefiting the activity in the border. And I think that there are some challenges in some of the markets as we got Juarez that has labor hand shortage. But on top of that, we do see enormous activity starting to happen. Again, I mentioned, and this is something new that we have been observing in this quarter, that there is an important group of new Chinese companies that in the past were not around, and I'm referring to Chinese, Chinese companies, which for me means companies that are not in the U.S., but that for the first time getting out of China, that aren't looking at Mexico to do important investments so they could have here a platform to export not only to the U.S. but to some other places. This is going to be a challenge because dealing with these new companies doing business abroad, China, it's not going to be an easy task. We need to be well prepared, have a great structure take care of these opportunities. But it is good news for the border and for the country that we're having this opportunity. Very bullish about the border. I think that we have a great opportunity. We have -- are very well positioned. Our sponsor has the important land bank in 3 of the markets in which we operate, and you should be expecting good news on this front going forward.
Your next question comes from Eugenio Saldaña with GBM.
I have one question. In the context of what you mentioned regarding the new trade agreement and the desire to invest in Mexico, the examples that you gave, do you fear that in markets such as Monterrey and Guadalajara that you barely mentioned, that are a little bit, of course, heated in some way? Good propel. This order on the supply or development side of the industrial state? Or if you think that is already happening, do you expect it to deepen? And I mean, I have a follow-up question. Do you -- are you considering somehow a repurchase of stock at this level?
Thank you, Eugenio. I will try to answer your question on Monterrey and Guadalajara. Let me start by Monterrey. Monterrey has been happening to be a great opportunity for us. Our strategy in Monterrey has been to have the best part in which the best companies are going to have operations. If you analyze our track record in Monterrey, you will notice that we have been focusing, through the effort of our sponsor, on the build-to-suit projects. Monterrey is a market, in which the small and medium developers, they do develop regardless of real estate fundamentals, and that makes it to be a complex market. So our focus there is to serve multinational, highly sophisticated companies, that they do now understand that there's a difference between engaging with a local developer than engaging with a company who is professional and could provide good service and could provide a building that is going to make them be more efficient in their operations. This is a strategy we'll keep on in Monterrey. Our sponsor will be announcing important news from this regard very soon, and we are optimistic about the way we are growing our business there. Guadalajara is a different story. Guadalajara is a very important city in Mexico, but the industrial market is not the most important one. There's ample liquidity in the marketplace, and this has brought some new competitors into the market to start doing development there. The market in Guadalajara has been kept flat. It has not reduced, but the supply on that space has been a little bit irrational considering the dynamic of the market. Out of the 6 markets in which we participate, I think that Guadalajara today is the weakest one. There is some pressure because of this additional supply to press rents down. In Guadalajara, we have an important customer base. We are leaders of the market, and we have a much better location than the new product that is being delivered. So our strategy in Guadalajara is the only market in which we are a little bit more defensive, rather than being offensive, and we have experienced some important latencies recently. But we are positive because of the pipeline and the work that our leasing teams are doing on the field, that we will be able to increase occupancy and to be between 93% to 95% by the second half of next year. I will pass the word to Jorge to comment on the repurchase product.
[Foreign Language] Eugenio, regarding your question on the stock buyback, the quick answer is no. At this moment, the discount today is between 15% and 17%. We wouldn't be acquiring, repurchasing stock. The reasons why is, one is liquidity on the stock. The float, our float is very small, so we're already small right now. By acquiring more stock, that would just decrease the stock. That includes, obviously, in order to do that, we have to leverage up the company by using the line of credit and so on, and so because of those reasons, we wouldn't be doing it. Not a deep discount. That's the main reason.
[Operator Instructions] Your next question comes from the line of Dan McGoey with Citigroup.
A quick question in terms of -- when you look at the net effective rents, Mexico City is relatively small premium to markets that you're mentioning, Guadalajara, Monterrey. And I'm wondering if you could just give a few thoughts on that as to whether or not you feel that, that rent differential has more room or should be wider given the constraints in Mexico City. And then you referenced in the notes that it's the lower barrier to entering markets that are seeing more supply. And obviously, you've touched on Guadalajara. But I'm wondering if you consider like Juarez and some of the border markets, also low barrier to entry. And whether the development yields in those markets are sufficient to be putting new supply in with where rents are today?
Thank you for your question, Dan. Let me start by Mexico City. Mexico City, without any doubt, is the market in -- is our largest market, at least the market in which we have the largest barriers of entrance for competition. Every time I meet with competitors, they ask me, how can I enter to the Mexico City market? And as you know, it's probably a little bit late in the game to try to see new players here, although we have seen several new players trying to chase land. Having said this, in Mexico City is where I think we have the ability to have a larger -- or the largest rent growth of the portfolio. I'm not surprised every time that the negotiation comps are reaching numbers in the double-digit, 10%, 11%, 12% digit. This is a situation that you need to operate carefully because the customer does not get happy when they receive the news that they need to increase the rent on that regard. It is a good thing that the peso demand in Mexico City is flat. I think that companies are learning to live with pesos and dollar leases, and we don't see an increase -- a peso increase in Mexico City. With the new cap, a lot of room on the current market conditions to increase the rent, but we do see that the market rent in Mexico City is going to go higher. So the picture that you are seeing today does not show how the market is. But for sure, I do anticipate rent growth to Mexico City in the range of 7% to 10% for next year.
Regarding our border markets, Tijuana has a natural barrier to entry, which is the land constraint. It's a market in which the land constraint situation is actually pretty similar to Mexico City. And our sponsor has engaged with El Florido, who is the largest landowner in Tijuana. So now we have a great land partner. That took us a while to put in place. And our sponsor will be starting to do important development activity in Tijuana next year. Regarding our business model, those buildings will be soon offered to the [team] once they are stabilized. Our strategy in Juarez and Reynosa is different because of our real offense is, which have been created in closed parks that happen to be identified by different users as probably the most secure and the most operating-efficient in the market. Companies, they do have alternatives, more than northern markets. But once again, our target customers -- our target companies are the multinational investment-grade companies. They want to be in the best projects, that they have security, they have systems to access, they have 24/7 service from our property management team. And that's the kind of business that we want to connect. There's not big barriers of entry. The rent growths that you could expect in Juarez and Reynosa are more moderate than the ones that you could expect in Tijuana or Mexico City. But they still make the math and are still a good opportunity for us. We need to mention that we are like an important airline and sometimes doing business with companies in Juarez and Reynosa translates into regional business to us in some other markets like Monterrey, for example. I think that our strategy of getting deeper into the markets is a strategy that keeps paying dividends. We are every day more and more important in each one of the markets, and that represents a competitive advantage for us.
Just a last complementation. So then, rent in Mexico City is over 13%, Mexico City to Guadalajara, and about 6% to Monterrey. We see this gap increasing in the future. And of course, cap rates in Mexico City are about 6.75% compared to maybe Monterrey and Guadalajara, which there's probably about 25 basis points. So given the land supply dynamics, we see this gap increasing as we move forward.
Your next question comes from Alan Macias with Bank of America.
I just have a question. Do you have any concerns on cost headwinds and the possible pressure on your margins, highlighting the increase in electricity costs that we have seen? Or perhaps, in insurance, higher insurance costs? And if you can share any cost control measures you might be implementing?
Alan, thank you for your question. I think that it's greatly accurate regarding current market conditions. It is a fact and it is a concern that electricity costs, particularly our [ boiler ] Importers. There are some markets in which the delta of electricity have gone beyond 75%, and this is something that really concerns to us. Prologis is a member of AMPIP, which is the Mexican Association of Industrial Parks. So at AMPIP, we're trying to do our common advantage to try to face the situation with the different authorities. This is not an easy task because the reason behind electricity costs going up is the fact that there is a lack on investment in infrastructure. And that lack, even our authorities, we will start working on it immediately, that they are doing it. It's going to take a while to be prepared. I've got to say, on the other side that none of our customers are high consumers of electricity. There are some operations in the north that they use air conditioning in their floor site, but it's not the relevant percentage of our portfolio. I've got to mention as well, that the efficiency and the competitiveness that Mexico represents on labor costs could eventually pay this price of a higher cost. I received this question a lot from Prologis corporate because construction costs in the U.S. are going up importantly. In Mexico, that is not the case so far. We have a component of dollars in our construction costs that are tied to the FX conditions. But overall, I think that construction costs in Mexico have been able to keep in a competitive manner, i.e. to measure much more competitive now in Mexico than in the U.S., and that represents an advantage to keep on providing additional space to users. The other cost that you mentioned regarding insurance and some others, I think they are not as relevant as the first ones that you placed, which was the electricity cost. It is an issue. We all need to work as a industry to try to solve this problem. At Prologis, we have an initiative that this called the smart light, in which we are in a process of renovating all the lighting of our different buildings to provide the new technology with LED, which has a much lower consumption of energy. It is part of our continuous improvement program, and our customers are already starting to be benefited from the situation.
Alan, this is Jorge. Just adding to Hector's point. Remember that most of our leases are triple net, so those costs pass to the tenant. And the other cost that you should have taken into consideration, obviously, is interest rates increase. Remember that most of our loans, 96%, 97%, is on a fixed rate, and this is why I mentioned that we're looking at some early refinancing to take advantage of current rates vis-à-vis waiting for rent to increase. So yes, we're taking measures on both fronts.
[Operator Instructions] Your next question comes from the line of Froylan Mendez with JPMorgan.
I actually have 3 questions. The first one, how are you thinking about resuming with any potential asset disposition now that FX could help on lower tax effects on the sale? That's the first one. Secondly, what is on the acquisition pipeline for 4Q '18? And how comfortable are you to fulfill your lower range of the guidance? And thirdly, can you expand a little bit on the evolution of land replenishment by the sponsor in Mexico City?
Thank you very much, Froylan. So yes, so as we announced early in the year, on the dispos, we decided to put on hold the dispo plan. We had guided initially from $0 to $200 million. And of course, the FX, it's a key component as we could potentially have a gain on earnings given our dollar debt, so we put that on hold. So this is something that we are monitoring. The market is very liquid. There is a lot of companies trying to enter the market. So eventually, our portfolio could have it successful. So this is something that we are currently considering, and we will closely monitor the FX and potentially trigger that lever if we see the right conditions. I guess, on the second part, we guided on the low part of the range, of $100 million. So yes, we will be meeting our guidance of $100 million and we expect this to complete in this rest of the quarter. And probably, an asset could probably jump to early next year, but we feel comfortable about meeting our guidance. And the third part of the question is Mexico City. Certainly, you see our pipeline. It's 4.8 million square feet. We are very happy at FIBRA Prologis with this pipeline because no other company has this amount of square footage ready with a guaranteed option to buy in parts and with their same client base. So FIBRA have this pipeline is Mexico City, and certainly, the sponsor is working on replenishing land in Mexico City. So today we have 1.5 million feet of available land, but the sponsor just increased from 0.5 million to 1.5 million, so there's a million increase in this quarter of a land which is right next to Grande. And that should be put to work next year. In addition, there's a couple of other pieces of land, which are also one of them below the toll booth, which is under option, and the other one is on the north side of the toll booth, as we see the scarcity of land very high. And this could be a great potential competitive advantage to play in Mexico City. But yes, there is a lot of work on that front.
There are no further questions at this time. I would like to turn the call back over to Luis for any closing remarks.
Well, thank you very much all for being here and listening to our earnings call. FIBRA Prologis has had an excellent momentum, and we expect to finish the year strong. I'm very much excited about our growth prospects. And before signing off, let me highlight where we are well positioned to continue to outperform. We own the best real estate serving the consumption and manufacturing sectors. The exclusive access to the Prologis development pipeline is a key competitive advantage. We have an in-depth understanding of logistic requirements for e-commerce companies, and we have a big head start relative to the competition. And we have the best real estate here in Mexico.
So thank you for joining on today's call, and we'll see you on the next one.
This concludes today's conference. You may now disconnect.