Automotive Properties Real Estate Investment Trust

TSX:APR.UN

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Automotive Properties REIT Third Quarter Results Conference Call. [Operator Instructions] This call is being recorded on Wednesday, November 14, 2018. I would now like to turn the conference over to Milton Lamb, Chief Executive Officer and President. Please go ahead.

[Milton Donald Lamb, President & CEO]

Great. Thank you, Joanna. Good morning, and thank you for joining us. With me today on the call is Andrew Kalra, our Chief Financial Officer. Our financial statements and MD&A for the quarter are available on our website and on SEDAR. Please be aware that certain information discussed today may be forward-looking and that actual results could differ materially. We'll also be discussing certain non-IFRS measures. Please refer to our SEDAR filings for additional information on both our risk factors and non-IFRS measures. Our Q3 results demonstrate continued growth in all of our key financial performance metrics. Property rental revenue in the quarter increased by 11.7% from Q3 of 2017. Cash NOI was up 11.9%. Our 1.4% growth in same-property cash NOI reflects the steady organic growth we generate from contractual rent increases. Funds from operations and adjusted AFFO were up 4.1% and 5.3%, respectively, from Q3 of last year. Both FFO and AFFO were up slightly. During the quarter, we completed the $55.5 million acquisition of 2 automotive dealership properties in major metropolitan markets from AutoCanada, one of Canada's largest and leading owners and operators of automotive dealerships. The 2 properties include the BMW Laval automotive dealership property located in Laval, Quebec, part of the metropolitan Montreal area; the Sherwood Park Volkswagen property located in Sherwood Park, Alberta, part of the Edmonton metropolitan area. This continues our focus on the major metropolitan markets, and our portfolio is now approximately 89% in the VECTOM markets. These additions of these properties are expected to be accretive to the REIT's run rate of AFFO per unit on a leverage-neutral basis. BMW Laval was built in 2000 and substantially renovated in 2011/2012. It includes 127,000 foot-plus, full-service BMW dealership facility and MINI dealership. It's located on 8.4 acres along a retail -- major retail arterial road surrounded by high-end dealerships and mid-density residential. Sherwood Park was built in 2015 and includes a 49,000 full-service Volkswagen dealership located approximately -- on approximately 4.5 acres with convenient access to the Yellowhead Highway in an area of substantial commercial development. Affiliates of AutoCanada are now the operating tenants of these properties and have entered into an 18-year triple-net lease with the REIT. These leases include contractual annual rent increases after the third year of the lease that is based on Consumer -- the Consumer Price Index. AutoCanada Holdings Inc. will provide an indemnity to the REIT with respect to all the lease obligations. We're pleased to complete our first acquisition with AutoCanada, highlighting our focus on partnering with leading automotive dealership operators that are active in the consolidating industry. Our portfolio now includes 4 of the top dealership groups in the country, including the top 3 groups by dealership franchise count. Concurrently with the transaction, we announced that we entered into an agreement to sell 5.1 million units of the REIT on a bought-deal basis for gross proceeds of approximately $55.1 million. This offering was successfully closed on October 16. We used the net proceeds from the offering to repay the debt incurred to fund the AutoCanada properties transaction, positioning us well for future growth. Looking ahead, we remain focused on taking advantage of the dealership industry consolidation, expanding our property portfolio in metropolitan markets across Canada while increasing AFFO in support of the unitholder distributions. I'd now like to turn it over to Andrew Kalra to review our results and financial position in more detail. Andrew?

[Andrew Atul Kalra, CFO & Corporate Secretary]

Thanks, Milton. Good morning, everyone. Property rental revenue increased to $11.8 million in the quarter, up from $10.6 million in Q3 last year, reflecting continued growth from property acquisition and contractual rent increases across most of our portfolio. Total and same-property cash NOI for the quarter were $9.3 million and $8.4 million, respectively, representing growth of 11.9% and 1.14% compared to Q3 a year ago. Cash NOI growth was attributable to acquisitions completed subsequent to Q3 last year as well as contractual rent increases, which also drove growth in our same-property cash NOI. G&A expenses for the quarter were approximately 7.3% of our cash NOI compared to 6.9% in Q3 last year. The slight increase was attributable to noncash compensation expenses related to the REIT's equity incentive plan and other costs. Net income for the quarter was $5.7 million compared to $12.7 million in Q3 last year. The variance is primarily attributable to the change in the fair value adjustment for Class B LP units, partially offset by NOI growth, changes in fair value adjustments for interest rate swaps and investment properties. FFO for the quarter was $6.7 million or $0.249 per unit diluted, up from $6.4 million or $0.244 per unit in Q3 last year. AFFO totaled $6.1 million or $0.228 per unit, up from $5.8 million or $0.222 per unit. FFO and AFFO growth was primarily due to the impact of the properties acquired subsequent to September 30 of last year. The REIT declared and paid total distributions of $5.4 million to unitholders in the quarter or $0.201 per unit, representing an AFFO payout ratio of 88.2%, down from 90.5% in Q3 last year. There were fair value increases of $1.5 million and $6.5 million to the REIT's value and investment properties for the quarter and year-to-date, respectively. These increases resulted primarily from cap rate compressions in Vancouver and Calgary and overall NOI growth from contractual rent increases. The assessment by the REIT of the overall portfolio resulted in an implied capitalization rate of 6.5%, which is consistent with year-end 2017. The valuation inputs are supported by quarterly market reports from an independent appraiser. I'll conclude with a review of our liquidity and capital resources. Over the last year, we increased and extended all 3 of our credit facilities. These transactions have further insulated us from potential interest rate movements and significantly enhanced our financial flexibility and acquisition capacity. In the quarter, we increased the amount available under the revolving portion of Facility 3 to $43.9 million in order to close the BMW Laval and Sherwood Park VW acquisition. The REIT had $339 million outstanding on its credit facilities at the end of the quarter with an effective weighted average interest -- fixed interest rate on debt of 3.48%. The REIT's debt to GBV was 53.1% at quarter-end. Following the closing of our equity offering in mid-October, the net proceeds were used to pay down the debt incurred to fund the BMW Laval and Sherwood Park VW property acquisition, reducing our overall debt by $52.4 million. The 2 properties remain unencumbered. We are well positioned to continue our grow -- AFFO per unit with our embedded contractual rent increases, mid to long-term interest rate certainty, strong liquidity position and the continued advancement of our growth strategy. I'd like to turn the call back to Milton for closing remarks.

[Milton Donald Lamb, President & CEO]

Thanks, Andrew. We're pleased with our continued growth in revenue, NOI, FFO and AFFO as well as the steady growth in our portfolio's NAV, demonstrating strong underlying value creation for our unitholders. The success of our acquisition program has played a large role in this, along with our stable, long-term leasing profile with contractual rent escalators, disciplined financial management and our demonstrated ability to access capital to drive continued growth. Our transaction with AutoCanada in the quarter was strategically important to us and further raises our profile within the Canadian automotive dealership community. Again, we now have 4 of the top Canadian dealership groups in our portfolio. Our equity offering further enhanced our liquidity and grew our market capitalization to over $300 million, continuing the strong momentum since our IPO just over 3 years ago. We remain confident in our outlook and focused on continuing to strengthen our portfolio by capitalizing on accretive consolidation opportunities, growing our cash flow in support of unitholder distributions and building long-term value for our unitholders. This now concludes our remarks, and we'll -- would now like to open up the line for questions. Joanna, please go ahead.

[Operator]

[Operator Instructions] And your first question is from Jonathan Kelcher from TD.

[Jonathan Kelcher, Analyst]

First question, just on the AutoCanada, and I'm sure you saw that they're looking to do more in sale leasebacks. Can you maybe give any sort of commentary on that to the extent you're able?

[Milton Donald Lamb, President & CEO]

Sure. I mean, we've had discussions with them for years, including this successful one last quarter. We certainly don't comment on rumors. We continue to focus on major metropolitan markets. So certainly, enjoy a good relationship with them, but can't really comment on that deal.

[Jonathan Kelcher, Analyst]

Okay. And you said in your remarks that the deal raised your profile. Has it helped to push along or open up any more discussions with other dealership groups?

[Milton Donald Lamb, President & CEO]

Opening up, a bit. Advancing, yes. Certainly, the more deals we do with groups that are non-Dilawri, the more that the dealership community understands that we are there to be utilized as for their growth strategy and consolidation strategy. And that certainly helps.

[Jonathan Kelcher, Analyst]

Okay. And then just secondly, on the -- on your development, it looks like you're mostly done, your spending on that.

[Milton Donald Lamb, President & CEO]

Yes.

[Jonathan Kelcher, Analyst]

You've turned it over to the tenant. When does that start paying rent?

[Milton Donald Lamb, President & CEO]

I guess 2 comments there. One is the remaining spend we have is the tenant inducement once they've completed work. Everything else, we have completed on time, on budget. And to your question, they should start paying rent in mid-January. Actually, they're obligated to start paying rent in mid-January.

[Jonathan Kelcher, Analyst]

Okay, so we'll see -- so when would your remaining $1 million and change sort of go to them for the fit-out?

[Andrew Atul Kalra, CFO & Corporate Secretary]

End of Q1.

[Milton Donald Lamb, President & CEO]

It depends on their time line, but I would think sometime in Q1.

[Operator]

Your next question is from Brad Sturges from Industrial Alliance.

[Bradley Sturges, Equity Research Analyst]

Just following up on Jonathan's question about your discussions with other dealership groups. I guess where are you seeing the most traction right now or the change in that dialogue? Is it with the smaller to mid-tier groups that are progressing along on their change in their business strategy? Or maybe give a little context in terms of the dynamics of the conversation and how that's evolving.

[Milton Donald Lamb, President & CEO]

Sure. It kind of straddles. What we're seeing is some of the small to mid are either deciding to look at potentially exiting. And so those are either being bought by other small to mids who want to grow in scale or certainly, the larger automotive dealership groups are still looking at the right opportunities and still want to be active in that consolidation world. So it's a bit -- when you're talking small to mid, are they looking at ramping up or are they looking at taking advantage of consolidation availability to actually exit and take some profits and go? So it's -- we're probably talking to more of the groups that are on the consolidating side, and they can range from the kind of small to mid up to the large.

[Bradley Sturges, Equity Research Analyst]

And there's still more exploratory discussions from these types of groups? Or are they more advanced than that at this stage?

[Milton Donald Lamb, President & CEO]

It's across the board. I mean, some of these deals take a lot longer than traditional real estate deals because it's alongside of operations deals. So it's varied, and you'll see some deals that you think are getting close to the end, and they take a pause. And other deals are hurry-up offense. The AutoCanada deal that we completed, that was probably about 3.5 weeks from handshake to close and about 48 hours between, "Would you be interested in these assets?" to, "Yes, let's close it."

[Bradley Sturges, Equity Research Analyst]

And in terms of your balance sheet and thinking about leverage, are you still targeting long term on sort of mid-50s leverage?

[Milton Donald Lamb, President & CEO]

We're comfortable in that range because we have a very clean bottom line. We don't have TIs. We don't have vacancy. We don't have CapEx. So yes, we're still comfortable in the mid-50s.

[Operator]

Your next question is from Matt Logan from RBC Capital Markets.

[Matt Logan, Senior Associate]

Just following up on Brad's question on leverage. Understanding that you're comfortable in the mid-50s range, where would you expect leverage to average over the course of 2019 in terms of capital deployment?

[Milton Donald Lamb, President & CEO]

I mean, with the most recent equity offering, obviously, we have some capability to go out there, and we plan to go out there and do acquisitions. It really depends on our pace of acquisitions. So that's a really hard question to answer without kind of pinning what quarters and what months we're doing acquisitions on. But I mean, I think it's comfortable to say that in that mid-50s, we're certainly comfortable at that level. Just how quickly we get there on the acquisition side, we probably went with a bit of a larger raise this time because we like what we're seeing in the marketplace.

[Matt Logan, Senior Associate]

Okay, fair enough. And for modeling purposes, how should we be thinking about the cap rate on the AutoCanada acquisition?

[Milton Donald Lamb, President & CEO]

We've been doing deals at the approximately 6.6 to, call it, 7.5. The interest rate market -- the fact that I really like that BMW Laval property and Edmonton remains solid, and you can argue that very easily that Alberta is coming back nicely, so I would say it's in the lower end of that range, but it's certainly not hitting a new low by any means.

[Matt Logan, Senior Associate]

Fair enough. And as we think about cap rates, your IFRS cap rate has been effectively constant since the IPO. How would we think about the IPO portfolio cap rate compared with changes in portfolio composition over the last few years?

[Milton Donald Lamb, President & CEO]

Obviously, we've ramped up a bit more in Montreal and Edmonton, so they would be a higher cap rate than would be a Vancouver and arguably a Toronto. It's a bit of a blending. As you can imagine, the Vancouver reduces that cap rate average and rightly so. It's very tough to buy in Vancouver right now. So I mean, really does depend on the markets you're looking at, but now as I mentioned, we continue to like focusing on the majors and especially the VECTOMs.

[Matt Logan, Senior Associate]

Well, I guess put differently, it would be fair to say you've seen cap rate compression for the IPO portfolio, but portfolio composition changes have basically kept flat.

[Milton Donald Lamb, President & CEO]

Yes. I mean, if you look at our -- we moved up over time our Calgary cap rates, and on the last quarter, we pulled it back just a bit. And then Vancouver and Toronto, I mean, it's really hard to argue that over the last 3 years, you haven't seen cap rate compression, and we've certainly seen that in our portfolio valuations.

[Matt Logan, Senior Associate]

Indeed. And last question from me. Just on Dilawri's rent coverage and trailing 12-month EBITDA, that's declined over the last couple of quarters. Can you maybe provide any color on that?

[Milton Donald Lamb, President & CEO]

Whether it's Dilawri or conversations we've had with the different dealership groups across the country and just industry overall, after record years in '15, '16 and '17, there was certainly a bit more inventory and expectations put on dealerships, which means probably a higher inventory. With a higher inventory, it probably means higher gross sales but arguably lower margins. But if the pendulum swings, it'll be interesting to see what the manufacturers are asking dealers to take next year. So I would think the record year over year over year, that is now kind of plateauing. We're off a bit, but we're off to what used to be record numbers in 2017. I think the next few years will be very stable [ instead of ] plateauing. So whether it's Dilawri or otherwise, I think this year, you've seen tighter margins across the dealership community. But on -- from our world, those are profitable margins. So that means we still get paid rent.

[Matt Logan, Senior Associate]

Yes, the rent coverage still remains very healthy.

[Milton Donald Lamb, President & CEO]

Very healthy. And the industry remains very healthy.

[Operator]

Your next question is from Tal Woolley from National Bank.

[Tal Woolley, Research Analyst]

Wanted to talk a little bit about credit availability for the dealers. And I'm just wondering, obviously, the industry is still running very hot, but it has cooled off a little bit. And I'm just wondering, for the dealers, what is their credit availability like from their local banks and stuff like that as the cycle might turn? I wonder if you've got any sort of like historical commentary because it seems to me like this would sort of be an opportunity, too, for you to replace some of that financing if the industry continues to cool a bit.

[Milton Donald Lamb, President & CEO]

Yes. I mean, I smile at the cooling because when you go from white-hot to red-hot, you're cooling. But it's probably not a bad place to be. From our understanding -- and we certainly talk to a lot of the same banks that finance a lot of the dealership groups because they're part of our various lending syndicates -- they still remain very interested in lending in the marketplace. I would say that's not an exact answer to your question, but one thing that does happen is we are more of a resource when people are looking at M&A and taking equity off the table to do other acquisitions. And if they are looking at our cost of capital compared to their cost of capital, we probably have the ability to push through interest rate increases because it's apples-to-apples versus if we're just knocking on a door to buy real estate in just pure and isolated basis. So when we're talking about the effective interest rates going up over the last 2 to 3 quarters, they understand that conversation implicitly. It doesn't include a lot of explanation, which is good.

[Tal Woolley, Research Analyst]

Okay. And then just lastly, in your conversations with Dilawri right now, any sense of what their -- what they might have available in asset sales over the next 12 months?

[Milton Donald Lamb, President & CEO]

Yes. Obviously, they have to, within 90 days, and that can be 90 days before or 90 days after, on either developments or acquisitions, provide us that right of offer. So we certainly understand what their portfolio is, but they have not disclosed and not put anything publicly on when and what they're doing with their developments they're doing. They continue to be on the same sort of pace of 5 to 6 assets a year of new acquisitions or new open points, including which approximately half of those would include real estate. They certainly focus on the markets that we like, the metropolitan markets, so we're very happy we still have that relationship very strong.

[Operator]

Your next question is from Mark Rothschild from Canaccord.

[Mark Rothschild, MD & Real Estate Analyst]

Maybe just following up on a question you were just answering. In regards to interest rates increasing, were you saying that you're able to get a little bit higher cap rate going in on deals? Or are you able to maybe negotiate better lease increases? Just want to make sure I understand that.

[Milton Donald Lamb, President & CEO]

Well, there's only a few levers that we have, so it's either the price or the rent increases. I think the conversation, to Tal's part of the question, is, does this mean there's going to be more availability because money is no longer free for dealers? I would say the answer is, we would think, yes, I think that helps us. And on the pricing, as it is a flow-through, whether it's on their leverage or on, in some ways, our leverage, and we charge them rent, it's an easier conversation to explain why we need certain returns. And to your comment on rental escalations, you'll notice on the AutoCanada, the CPI is a good thing. So we're starting to look at mixing up our leases between contractual, hard-quoted rent increases and some that float with CPI.

[Mark Rothschild, MD & Real Estate Analyst]

Okay, great. And just in regards to the property taxes, which we see a little higher this quarter, is that just something we should kind of expect that it's going to jump around quarter-to-quarter? Or is there anything specific now?

[Andrew Atul Kalra, CFO & Corporate Secretary]

It will jump around quarter-to-quarter in terms of how we're billed, and that's how we account for it. We do do accrual on a quarterly basis, but sometimes there'll be timing differences.

[Mark Rothschild, MD & Real Estate Analyst]

Understood. But it's going to be -- ends up being a flow-through?

[Andrew Atul Kalra, CFO & Corporate Secretary]

It's a flow-through, sorry.

[Mark Rothschild, MD & Real Estate Analyst]

Right. Yes, no, I understand.

[Andrew Atul Kalra, CFO & Corporate Secretary]

Yes.

[Operator]

[Operator Instructions] Your next question is from Pammi Bir from Scotia Capital.

[Pammi Bir, Analyst]

Just as you look at some of the players at the table on transactions, have you noticed any change in who's there? And maybe just some commentary on who you're seeing at this stage.

[Milton Donald Lamb, President & CEO]

On the table, as in buying audience?

[Pammi Bir, Analyst]

Yes. Just who are you bumping up -- in terms of when you're bidding on acquisitions, has there been more interest in the space from other financial players or, again, the dealership owner base?

[Milton Donald Lamb, President & CEO]

Yes. It still remains pretty quiet on competition. We've talked before that Brookfield with Capital Automotive, they've popped their head up once or twice this year. On the institutional side, we're not seeing it. On the private side, we rarely see it. Certainly, dealers, especially with the availability of bank financing, can often decide to keep it on their own balance sheet. I think that's easier for them to do when they're buying one deal at a time and slowly going. If the pace picks up or they're looking at small to midsize portfolios, those are bigger tickets to do. But really, it's still the dealers owning their own, and then we don't really run into bid situations.

[Operator]

At this time, we have no further questions. You may proceed.

[Milton Donald Lamb, President & CEO]

All right. Well, thank you, everyone, for joining us. We look forward to talking to you shortly. All the best.

[Operator]

Ladies and gentlemen, this concludes today's conference call. We thank you for participating, and we ask that you please disconnect your lines.