Prologis Property Mexico SA de CV

OTC:FBBPF

Earnings Call Transcript 2021-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the FIBRA Prologis third quarter earnings conference. [Operator Instructions]. I would now like to hand the conference over to Alexandra Violante, Head of IR. Please go ahead.

[Alexandra Violante, executive]

Thank you, [ Demetrice ], and good morning, everyone. Welcome to our third quarter 2021 earnings conference call. 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 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 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 update forward-looking statements in the future, whether as a result of new information, future events or otherwise, except as required by law.

That is our practice. We have 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. With that, it is my pleasure to hand the call over to Luis.

[Luis Gutierrez, executive]

Thank you, Alex. And good morning, everyone. The market continues to accelerate, and real estate KPIs are set to break records in absorption, rental prices and higher valuations. This continues to be a global phenomenon, and Mexico is not an exception. As a result, this quarter, we have delivered an outstanding operational performance and solid financial results. Let me provide some highlights. We had a high and healthy occupancy of 97%. This is 60 basis points above last year until October 2014 positively has been above 95%. Rent change is north of 7% and are in place to market widened as market rents spiked.

We continue to have a growing cash flow generation with a high same-store cash NOI. For the 9 months, FFO increased 7% compared to the same period of last year, while AFFO was higher by 16.5%. Additionally, during the quarter, we acquired 2 properties from our sponsor, an investment of $35 million that will contribute 465,000 square feet to our portfolio. These properties are in the most desirable of markets within Monterrey and Juarez.

In the context of global supply chain disruptions and bottlenecks, the tendency of tenants has been taking action, shifting from adjusting plant inventory level to a larger stock to prevent supply stops and meet the demand from their clients. With that in mind, the actual environment is good news to our business regarding the logistic [ market ] space, and we expect it to remain well into the next year. We are seeing historical levels of net absorption in all of our markets, driven by e-commerce and manufacturing.

Rents have been increasing, driven by favorable demand supply fundamentals, rising land prices, high replacement costs, and we believe that this trend will continue into 2022. We are expecting the year to close with 65% more demand for space than 2020, and vacancies are trending below 3% with an approximately 10% market rental growth. In the last 12 months, demand was 27.2 million square feet in our 6 markets, which exceeds supply by almost 3 million feet.

Let me briefly discuss what we're seeing on the ground. On the manufacturing side, it has be planned very well. We are seeing a strong pipeline of customers who will need to expand their operations in Mexico. Nearshoring and U.S. labor shortages have been the main drivers. The pipeline for build to request is something we haven't seen before. Our sponsor has around 15 requests for approximately 6 million square feet. For example, in Monterrey, we had 2 expansions for 380,000 square feet from 2 existing clients in the paper packaging space.

On the logistics front, e-commerce continues to be active as leading companies are expanding their presence in middle cities. They're also building out their infrastructure in core markets and now require other assets such as storing facilities or transportation platforms. We are seeing expansion plan and more requests for [indiscernible] locations. Prime assets are expected to outperform in the long-term as companies invest in automation technologies, service levels. And transportation represents a higher bucket of tenants, time and money.

For example, one of the leaders in e-commerce business and our client made 2 expansions in some of their existing locations in Mexico City in [indiscernible] and [indiscernible] to meet the increase in volumes. As labor gets tight in the U.S., we're having request for e-commerce operations in Reynosa. Logistic real estate has been the preferred asset class, attracting new investors and developers store markets. We believe it is time to play offense in our capital strategy, and we are preparing the company to continue growing.

During this fourth quarter, we will see closings from the Prologis pipeline until from third parties materializes. Preparing for the future, our sponsor will increase our development pipeline to around 4 million square feet, which will be available for the FIBRA to acquire in the next 12 to 24 months.

In addition, Prologis is in the process to replenish the land bank and increase its capacity in all of our markets. We remain focused on delivering sustainable growth in an accretive manner, and we're well positioned to take advantage of the opportunities that are out there.

To sum up, our results are strong, and we continue to add shareholder value through our quality portfolio that is well positioned in the highest growth markets. Our internal growth as there is a great opportunity for the team to increase rents on rollover; external growth, and we're putting our capital to work in an environment of righting values, which provides capacity to take on investment opportunities.

Our strong balance sheet, which provides us with a major competitive advantage, and I am very proud of our team. We're a strong culture of service and our ESG commitment and excellence. We believe that FIBRA Prologis offers one of the most compelling investment opportunities available today. With that, let me turn the call over to Jorge.

[Jorge Girault, executive]

Thank you, Luis. Good morning to everyone, and thank you for joining us. Given the solid results we have been delivering in 2021, we will adjust our guidance for the year. FFO for the quarter was $36 million, a 2% decrease on a per certificate basis, if compared to last year. This is due to a nonrecurrent event of revenue from currency exchange gain derived from the reimbursement of BAT based on the acquisition of Grande.

If this was taken out, we would have been delivering a 10.5% increase this quarter. A -- FFO for the quarter was $29 million, an increase of 3% compared to last year. Leasing activity for the quarter was 1.3 million square feet, addressing on a cumulative basis, 87% of total lease expirations for the year. Net effective rent change on rollover increased 7.4%. And for the last 12 months, it had a positive change of around 11%.

For the quarter, same-store cash NOI was positive 12.5%. And for the last 4 quarters, was 8.2%. It was mainly driven by less rent concession, stronger FX, rent increase on renewals and customary annual costs.

Regarding our balance sheet and capital market activity, last July, we received $300 million from our U.S. Private segment, completing our refinancing effort that started in December 2020, ending with a loan-to-value of 27%. On this regard, I would like to highlight a follow-up.

Taking advantage of low interest rate environment, we have now fixed 100% of our long-term debt at a weighted cost of 3.9% and increased our weighted debt maturity to almost 10 years. We have smoothed out our debt exploration profile by having, on an annual basis, exploration columns at prudent levels. And our total Green or sustainable financing has reached more than 60% from 0 last year.

From a liquidity standpoint, we have an unsecured and committed line of credit for $500 million, including its according feature. From a credit rating perspective, this October Fitch rectified FIBRA Prologis BBB credit rating on a global scale, which supports our investment thesis and our financial discipline. On the valuation front, our portfolio value increased 8% year-to-date.

Switching to guidance. We are going to do the following adjustments. Regarding year-end occupancy, we're increasing the range between 97% and 97.5%. This is a 175 basis point growth from the previous midpoint range. For same-store cash NOI, we are increasing 500 basis points from the midpoint of the range. We now expect to be between 8% and 10% for the year. And we are decreasing our CapEx as a percentage of NOI by 50 basis points from our midpoint of the range to be between 12.5% and 13.5%. For additional information, please go to Page 7 of the supplemental financial package.

On the ESG front, last July, we released FIBRA Prologis first ESG annual report, which is available in our website. And for the second year in a row, we are named sector leaders from the global real estate sustainability benchmark or GRESB.

To sum up, the third quarter was a continuation of what has already been a very good year, and I feel great about our growth outlook. With that, I turn it to the operator for Q&A. Thanks.

[Operator]

[Operator Instructions]. Your first question comes from the line of Gordon Lee with BTG.

[Gordon Lee, analyst]

A couple of questions actually on the Reynosa market. I was wondering if you could describe maybe what happened during the quarter. I assume the slippage in occupancy is sort of maybe a single-tenant move out, given your comments on the market. But it would be interesting to see if there's something more of a trend there.

And you mentioned, during your remarks, that you were seeing maybe as a result of the labor shortages in the U.S., demand for e-commerce logistics space and Reynosa. Is that demand that would be permanent for Reynosa? Or do you think it's temporary just while we deal with sort of these shortages?

[Hector Ibarzabal, executive]

Gordon. Good morning, everyone. It's interesting that this first question comes from the Reynosa market. The Reynosa market is one of the border markets, and we have a very clear leadership. And it's a market actually that we like a lot, and it has been shy for a while. If you review the operating metrics in Reynosa, occupancy is below 90%. But the lease space is 99.1%. In other words, there's a number of customers that are in the process of moving in space.

The reason because the former customers left was because we were not able to provide additional expansion. A sponsor is planning on importantly developing in Reynosa and starting this fourth quarter and in 2022. We are seeing an important activity, and I think that we are better positioned than anyone to take advantage of that.

Regarding the e-commerce operation in Reynosa, I think that this trend is coming to stay. I don't see this as a permanent way -- as a permanent activity, but we are seeing not only the top names, but some of the names jump into the market. There are some e-commerce activities that take advantage of the accessibility to labor [ camp ], in need to provide fulfillment operations and e-commerce sales into the U.S. and Reynosa, Tijuana, Juarez will get benefited as well in this trend. It's not necessarily showing, but it is a new driver of demand for those markets that in the past don't exist.

[Operator]

Your next question comes from the line of Sheila McGrath with Evercore.

[Sheila McGrath, analyst]

I have 2 questions. The cap rate compression, globally, in industrial has been significant. I was wondering if you could give us your perspective on how much that has impacted Mexico and where Mexico stacks up globally on real estate valuation? And then my second question is where -- I think, Luis, you mentioned in-place rents compared to market that's widened. What is the estimate of the discount in-place rents compared to market?

[Luis Gutierrez, executive]

Thank you, Sheila. So yes. So I mean, logistic real estate will have its best year globally. And of course, as you mentioned, Mexico is not the exception. We have been seeing very good cap rate compression in Mexico. Of course, this has been driven by higher rents and the increased liquidity of other players. We think cap rates have decreased around 80 basis points. And if you have to break down how this has happened around the markets. It's been led by the border, around 190 basis points, mainly led by Tijuana and Juarez and some cap rate compression in our other markets.

So we believe cap rates are in the low 6s, and we are seeing cap rates at that level in 4 of our markets, Tijuana, Juarez, Mexico City and Monterrey. And then you have kind of a spread in Guadalajara and Reynosa. Our values continue to increase 8% year-to-date, and we estimate around 15% in the last 12 months. How does this compare to the global markets? I think our cap rates are the highest globally.

If you see the Mexico City cap rates and compare them to Los Angeles, Los Angeles is probably at the low 3s. So you have between 235 basis points to 300 basis points, that has widened. So I think in that sense, we are still seeing that there may be some more compression for increased valuations.

[Hector Ibarzabal, executive]

Regarding your question about market trends, let me provide some information that I think is interesting. Market rates have increased year-over-year, 7.7%. This is market rents. Replacement rents compared to market rents is still between 4% to 5% above. This is a clear evidence that market trends will keep on increasing. And our in-place rents compared to market trends, is -- our best estimation is between 6% and 6.5%. So these 3 figures make us think that the trend on increasing rents and increasing value of the assets as a consequence, as Luis mentioned, will keep on happening in the following quarters.

[Operator]

Your next question comes from the line of Francisco Suarez with Scotia Bank.

[Francisco Suarez, analyst]

Congrats on the results and on the increased guidance. My question relates with your initial remarks are very helpful Luis, on the pipeline on Prologis. I noticed that PLD has starts of roughly 1.2 million square feet just announced in this quarter. Given the comments that you made in the first place, do you think that the level of starts is only going to increase? And on that front, does the northern markets -- are likely to receive priority over market, say, Guadalajara or that is more likely to be much more heavily spread across your entire footprint?

[Luis Gutierrez, executive]

Thank you, Franco, for your question. It's interesting to see how our business is perceived. I think that probably last quarter and a couple of quarters ago, and we talk all the time with investors and analysts, it looks like logistical and e-commerce, we're the king of the universe. And certainly, the strong fundamentals before -- behind this activity are real under which -- on improving. But we are very comfortable as well with our manufacturing strategy.

I think that the diversification that FIBRA Prologis has between 2 activities is the right one. The nearshoring activity, let me provide you some figures. In 2020, it represented 11% of all the activity that happened of the net absorption. And just in the first half of this year, this number was 12%. We're expecting that by year-end, [ recover ] to be in the neighborhood of 20% of nearshoring activities compared to other demand.

I commented in the previous question, how e-commerce and logistics is becoming more important in the border. Companies are needing to reach inventories. So we are seeing more warehousing in the quarter happening in the 3 markets in which we participate. And this is a complement of what is happening in Mexico City. In Mexico City, problem number one today is the challenges to combining the space. My opinion is that everything that we develop in the right location in Mexico City will be absorbed immediately, and we're working in that regard.

Monterey is going to be having a record year ever. A lot of activity. It's a hybrid market. You have manufacturing and you have e-commerce. And the size of the requirement is going up as well. Guadalajara is a market that deserves special attention. It's a market where we all feel activity should be higher, and we are actively investing in that market, but the pipeline in Guadalajara is probably the weaker of the 6 markets in which we participate. That doesn't mean that it is not a good market, but that's the way the score is today.

[Francisco Suarez, analyst]

And can you expand on the stats on PLD that we know is in Mexico of 1.2 million square feet. Do you think that number is going to increase the number of stats given the remarks made at the initial of the call?

[Jorge Girault, executive]

Yes, Franco, we're actively developing in all of our 6 markets. PLDs also is filling up the land back that has been getting empty recently. And we expect for next year even to have a higher activity on the development side and in all of the markets, in the 6 markets compared to what we have -- what we are going to be having in 2021.

[Luis Gutierrez, executive]

In addition, Franco, the sponsor is replenishing the land bank. If you see our supplemental, we have capacity for 6 million square feet of development. But I think by the end of next year, this number would probably triple.

[Operator]

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

[Vanessa Quiroga, analyst]

So I wanted to ask you more specifically about different absorption between logistics clients and manufacturing clients, do you see a difference in absorption? And if this is being affected by supply chain issues? And if you see a specific regions more affected by supply chain issues in different magnitude?

[Hector Ibarzabal, executive]

Thank you, Vanessa for your question. As I mentioned in my previous question, I now recently visited all of our border markets. We are seeing that companies that were focused or are focused in manufacturing, either they are signing a larger space within their facility to do warehousing of raw material because the disruption of the supply chain is very painful for these companies.

And we are seeing more activity on third party logistics, I can probably guess that more than 50% of the companies have decided to use 3PLs in the border in order to take care of this additional need of additional warehouse space. Absorption -- you were requesting about absorption. Monterey is having, as of today, have very similar absorption to Mexico City. And this is linked to the comment that I made on the fact that Mexico City today is probably one of the most challenging markets, hand by hand with [indiscernible] to supply new space.

You need to anticipate everything that you need to do in assembling, entitlement, construction, et cetera, in order to be able to catch up with the pent-up demand. So in conclusion, more warehousing activities in the border, more logistic activity in the quarter and very challenging to supply space in Mexico.

[Luis Gutierrez, executive]

And Vanessa, just to give you some additional color. There is some spaces, which we have never seen this happening. We have 3 or 4 clients, 1 in the space and filing for it.

[Operator]

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

[André Mazini, analyst]

Yes. Everyone, Luis, Jorge and Hector. So the first question is on something that Luis mentioned in the beginning, the company is under -- adjusting a little bit from the just-in-time inventory management that they had back in the [indiscernible] to something more inventory heavy, right, given that supply chains are stressed and to make sure that products get there on time and don't have any disruptions.

Do you guys have any sense of how that -- the demand for GLA changes given the new mindset of companies should be more inventory heavy? And if the change is great for the manufacturing clients, I would imagine so, for the manufacturing and less so for the logistics clients. So this is the first question. And the second question is on customer retention. So you guys mentioned that a decrease given.

[Audio Gap]

It's really as simple as that, which is a good news.

[Hector Ibarzabal, executive]

Thank you for your question, Andre. Effectively, this optimization of supply chain is rapidly evolving in these days. As I mentioned in the past, the most expensive thing for a customer is not to have the finished product. That has a very important impact on them. So everyone -- and this is a trend. Everyone is increasing inventories and once you're increase inventories, you need additional space, and that is what is happening.

We see customers taking space sooner than what they were anticipating or what they were needing in order to have the certainty that the space is going to be there when they need it. Luis mentioned, one of the issues that we face with customers -- and we're a company that focus a lot on customers is that eventually and every day more often, we have important customers of ours fighting for the same space.

So price is not as important today as availability of the space, but we are being respectuous, and we are increasing brands who are taking good care of our customers. Your question regarding customer retention of -- I mean, I'm not concerned about retention because we have a very high occupancy. But why are customers leaving, which is probably another way of making this question. 50% of our companies are leaving because they're consolidating -- because they are being bought by a bigger company.

And 50% of our customers, and that's a high figure are leading the space because we don't have availability to provide expansion area. So this is a point of attention, and this is why Prologis is focusing important investments on the development side. What was the last question, André?

[Luis Gutierrez, executive]

Comment on occupancy.

[Hector Ibarzabal, executive]

Comment on occupancy, no concerns. Reynosa, I mentioned in the first question, This lease don't occupy the numbers that you see are related to state lease and occupies. But we have some time that it takes a few weeks to do the [indiscernible] and to have the customers in place.

[Operator]

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

[Wilfredo Guilloty, analyst]

I have 2 questions here. The first one is, looking at your maturity schedule, you have 15% of your rents coming due or being mark-to-market next year. I just wanted to get a sense of if you can provide a little bit more clarity about how that breaks down either by region or by city? And what sort of mark-to-markets we can expect for -- what's coming due next year?

And then the second question is you mentioned that the sponsor is looking to replenish the land bank. And I'm sorry, you mentioned this earlier, but just wanted to get a sense of where exactly would you be looking to replenish? And then connected to that, what is the dynamic with land pricing? I mean, are you seeing a material increase in land prices? Or are you trying to get ahead of that, given the demand for the space?

[Hector Ibarzabal, executive]

Thank you for your question. Let me try to answer the second question first. Land prices are going up importantly. We're seeing some markets, Mexico City and Tijuana, where land prices year-to-year have increased between 75% to 100%. This situation gets more complicated if the market, that you are referring, has issues with electricity. Land with electricity in markets where there's no electricity available, could get really crazy prices.

And this is why land is part of the replacement costs. And I was mentioning one of the questions, how importantly the replacement costs have increased, and Luis make this as part of his opening remarks. So all this trend is making rents going up. And this is why we are having this year higher almost twice the rent change that we were expecting the portfolio and market trends are going up.

Regarding the maturity schedule, next year is -- we're going to have twice the leasing activity that we have this year. But we will have the lease activity that we're used. 2021 of this regard was exceptional because 50% of the job in activity from 2020. So 2022, we're expecting to keep a very similar occupancy than the one that we are going to be having in 2021. We do not have concerns on the rollover. On the contrary, we have good expectations to have an ability to keep on increasing rents on this regard.

And we have some important rollovers. The market in which we have more leasing activity is the Mexico City market, where we have around 1.5 million, but we have in acquired approximately 800,000 square feet. Those are the 2 markets in which we are having more leasing activity next year.

[Luis Gutierrez, executive]

We're expecting double-digit spreads on our rollover next year, in addition.

[Operator]

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

[Unknown Analyst]

So we noticed that [indiscernible] revaluation of assets quarter-over-quarter, mainly in Mexico City and Guadalajara and in the manufacturing markets, which seems to have drove the use of lower coverage or the valuation of your properties. Could you provide more detail on what is driving these dynamics?

[Luis Gutierrez, executive]

Yes. For sure. As I mentioned earlier, we've seen cap rate compression of 80 basis points. And if you break this down, it's probably 180 basis points in the border markets and around 40 basis points in Mexico City, Guadalajara and Monterrey. So why is cap rates decreasing more? And of course, this is reflected in valuations. Tijuana market is where you see the highest volume increases, and this is where we have seen the highest cap rate compression.

And mainly this is driven by a market that is very much macro strained. Vacancy in Tijuana is probably below 1%. And then market rental growth is around 20% for 2021. So this is driving a lot, Juarez has kind of the same dynamics. Vacancy is below 1.5%. And you can say that Juarez has a lot of land, but not with infrastructure. So that is also something that is playing the benefit of Juarez.

And certainly, in both markets, you have dollar-denominated rents, and that plays well into the further cap rate compression. So that would be the comments that I would have on this update.

[Operator]

[Operator Instructions]. Next question from the line of Armando Rodriguez with Signum Research.

[Armando Rodriguez, analyst]

I had just a quick question. Considering this strong leasing demand and the FX and inflation environment, what's your view -- what your short-term view on the mix between the dollarized and peso denominator grows on your portfolio? That's my only question.

[Jorge Girault, executive]

Thank you, Armando, this is Jorge Girault. Thank you for your question. We're seeing -- as we have seen before, a balance between pesos and dollars, between 2/3 being dollars and 1/3 being pesos. That's more or less where we have seen the markets. Of course, if we grow more in Mexico City, you get more peso, because it's a more peso market. But going forward, I think we're going to maintain this type of tenants.

The peso dollar leases are, as I said in my first part of the answer depends on the market. So Mexico City, you will see more pesos as well as Guadalajara, the border market, you will see more dollars or mainly owners. So we expect, in short, to be 2/3 dollars and 1/3 pesos.

[Hector Ibarzabal, executive]

Let me provide here an interesting figure. Jorge mentioned that the Mexico City market is a peso market and indeed, it is a peso market, every day more and more. In some of the renewals, just by CPI adjustments, we are receiving almost 7% increase in those markets. A hard number that reflects that peso leases in Mexico City are none of our business is the rent change figures that we have in this quarter for Mexico City is 9%, and this is in dollar terms.

So eventually, in the midterm, our peso leases always catch up with dollar leases. And you have situations like the one that we are facing that FX has been stable, inflation has not, and you have this important catch up on pesos. You cannot [ rely ] on the market, Mexico, Guadalajara, more pesos to expect, the other markets more dollar to expect prospect, and that takes us to what I think is a very convenient balance.

[Operator]

At this time, there are no further questions. I would nowlike to turn the call over to Mr. Luis Gutierrez, CEO.

[Luis Gutierrez, executive]

Thank you very much. We would like to thank everyone for their time today. This has been the best year in logistic real estate ever. And I think FIBRA Prologis is greatly positioned. I want to take the opportunity to mention that AMEFIBRA, the Mexican association of FIBRA's will host a FIBRA Day on November 4. This will be an event in person in the beautiful city of San Miguel De Allende, and I look forward to sharing all industry trends with you all. I hope you can join us. I'm looking forward to a great year end closing, and thank you very much. Looking forward to seeing you soon.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.