CT Real Estate Investment Trust

TSX:CRT.UN

Earnings Call Transcript 2019-Q1

[Operator]

Good afternoon. My name is Alderize, and I will be your operator for today. At this time, I would like to welcome everyone to the CT REIT First Quarter Earnings Results Conference Call. [Operator Instructions] The speakers on the call today are Ken Silver, Chief Executive Officer of CT REIT; Lesley Gibson, Chief Financial Officer of CT REIT; and Kevin Salsberg, Senior Vice President of CT REIT.Today's discussion may include forward-looking statements. Such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements.Please see CT REIT's public filings for a discussion of these risk factors, which are included in their 2018 MD&A and AIF, which can be found on CT REIT's website and on SEDAR.I will now turn the call over to Ken Silver, Chief Executive Officer of CT REIT. Ken?

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator, and good afternoon, everyone. We're very pleased to welcome you to CT REIT's First Quarter 2019 Investor Conference Call and to share with you the results of another strong quarter. I'm going to turn the call over to Kevin Salsberg, our Senior Vice President of Real Estate, to provide an update on our investing activities and operations. Lesley Gibson, our Chief Financial Officer, will then review the financial aspects of the quarter, and I'll wrap things up before turning the call over for questions. Kevin?

[Kevin Salsberg, Senior Vice]

Thanks, Ken, and good afternoon. We are pleased to start the year with strong results and the announcement of new investments this quarter totaling $33 million. These new projects are comprised of 1 vend-in from CTC, 2 Canadian Tire store expansions and several new third-party developments on existing CT REIT-owned properties. Although historically we have not provided regular updates on the progress of our pad pipeline initiative, we felt that it was appropriate to relay our plans for the balance of the year based on the great work our team has been doing and the number of projects that we expect to come to fruition in 2019.In total, these investments when completed will result in an incremental 118,000 square feet of gross leasable area being added to the portfolio and are expected to earn an average going in cap rate of 7.1%.Additionally, we invested $54 million in the first quarter towards previously announced investments. These projects included 3 new Canadian Tire store developments in Grand Falls-Windsor, Newfoundland; Mount Forest, Ontario; and Grande Prairie, Alberta. The Grande Prairie location is now being Canadian Tire's largest single-level store in the country.The REIT also completed the redevelopment of a redundant Canadian Tire location in Calgary, Alberta for a third-party grocery store, the intensification of a property in Toronto, Ontario for a third-party grocery store as well as the intensification of a property in Bradford, Ontario for Canadian Tire Gas+ gas bar and car wash.As previously disclosed, CT REIT investments in the quarter also included the acquisition of a stand-alone Canadian Tire store in Alberta from a third party.In total, these investments increased our GLA by approximately 373,000 square feet.At the end of the first quarter, CT REIT had 28 properties under development. These properties represent a total committed investment of approximately $240 million upon completion and a total gross leasable area of 1,268,000 square feet, nearly 92% of which has been pre-leased.On a committed basis, our portfolio is 99.1% occupied as of the end of the first quarter, a slight increase over Q4. This modest increase relates primarily to Canadian Tire leasing approximately 1,000 square feet at our 11 Dufferin Place Southeast property in Calgary, Alberta on a short-term basis for additional seasonal requirement. We expect that this short-term occupancy will likely only be required by CTC until the end of Q2.With that, I'll turn it over to Lesley for a review of our financial results.

[Lesley Patricia Gibson, Senior VP & CFO]

Thanks, Kevin. Good afternoon, everyone. Before I get into our results, I would like to highlight an accounting change that has impacted our results. As you are aware, IFRS 16 on leases came into effect January 1, 2019. This new accounting standard is most impactful for lessees as the standard lines of presentation of leased assets to be similar to owned assets, resulting in both asset and liability being recorded on the lessee's balance sheet. As CT REIT has only 10 ground leases, the impact of conversion to IFRS 16 was relatively minimal. The adoption of IFRS 16 has resulted in recognition of a right-of-use asset, which is classified as part of investment properties and the lease liability for all operating leases with CT as the lessee. I do want to highlight that IFRS 16 does not change the underlying operations or economics of our business. To ensure comparability year-over-year, we've adjusted the 2018 net operating income to exclude ground lease expense to achieve consistency in reporting under the new standard. The disclosure will be provided for the balance of 2019. In addition, the definitions of FFO and AFFO have been adjusted for IFRS 16 in accordance with the updated REALpac definitions, which consisted of a new deduction for the principal payments related to the lease liability.Moving on to Q1 results. We reported FFO per unit diluted of $0.288, an increase of 4% compared to the $0.277 per unit diluted in Q1 2018. AFFO per unit increased 5.2% to $0.245 as compared to $0.233 in the comparable period. Both increases were driven primarily by the impact of acquisitions of income-producing properties and properties under development completed in 2019 and 2018.Reported NOI was $89.9 million for the quarter, increasing 5.4% compared to the same period in the prior year. As I mentioned, this is after excluding expenses related to the ground rent and NOI for 2018 as a result of the adoption of IFRS 16. This growth was primarily driven by the acquisition of development activity that was referenced previously, which contributed $1.9 million to NOI growth this quarter.The same-store NOI growth of 2.8% and same property growth of 3.2% were driven primarily by 2 components. Firstly, the average rent escalations of 1.5% within the Canadian Tire store and CTC distribution center leases. And secondly, the recovery of capital expenditure and the related interest earned. In addition, this quarter compared to Q1 2018, there was a positive NOI impact related to the changes in tenancies at 11 and 25 Dufferin Place in Calgary, Alberta that occurred last year.G&A expenses as a percentage of property of revenue increased to 3.9% versus Q1 2018 primarily due to the change in fair market value of CT REIT's unit price. If one excludes the fair market value changes, G&A expenses as a percentage of property revenues decreased to 3.0% versus 3.1% in the prior year. Included in G&A expenses this quarter was approximately $400,000 related to our previously announced property management insourcing project.I would like to note that effective May 1, we have now gone live with this project including the implementation of our new ERP system and the internalization of property management functions related to majority of our multi-tenant assets. With the hard work and effort of the project team including individuals in both CTC and the REIT, we've successfully entered a new stage of CT REIT, where we are much better positioned to optimize results from our portfolio and to develop internal capabilities that we believe will be meaningfully contributed to CT REIT's future.While we're still in the early stages of rolling out this project, we continue to look to ways to optimize the process from our learnings [indiscernible] in Q2 and expect that there will be a net positive change related to general and administrative expenses and property operating expenses once the transition is complete in the latter part of 2019. The balance of the project costs of approximately $700,000 are expected to be incurred in the next 2 quarters.Lastly, in Q1 2019, we saw an increase in interest coverage ratio to 3.35x as compared to the same period in 2018 due to the growth in EBITDA as we exclude in this growth interest and other financing charges as well as the impact of IFRS 16.Moving to the balance sheet. We continue to hold a strong financial position. As of March 31, CT REIT's indebtedness ratio was 44.1% compared to the indebtedness ratio of 45.1% as of December 31, 2018. The decrease in this ratio is due to our continued investing activities, fair value adjustments made to the investment property portfolio and the IFRS 16 related impact of including the right-of-use asset in investment properties, partially offset by an increase in total indebtedness.We also have approximately $288 million available on our credit facility as well as over $8 million of cash, which keeps our balance sheet in a strong and liquid position.Our AFFO payout for this quarter was 77%, lower by 1.3% than in Q1 2018. The decrease is mainly due to the growth in AFFO exceeding the rate of increase in our distributions.Distributions per unit for the quarter amounted to $0.189 or 4% higher than the same period in the prior year due to the increase in the annual rate of distribution effective with the first distribution paid in 2019.I would also like to speak to the trend of book value per unit. As at March 31, 2019, the book value per unit was $14.15, representing a 4.5% growth over the book value of $13.54 reported at the end of Q1 2018. The main contributing factor was the increase in our net income exceeding distributions.With that, I'll turn it back to Ken.

[Kenneth Silver, President, CEO & Trustee]

Thank you, Lesley. We're delighted to kick off 2019 with another strong quarter, a quarter characterized by attractive growth, underpinned by a solid balance sheet and financial metrics and an increase in the distribution to unitholders. As I described at our AGM this morning, our ability to consistently deliver these kinds of results is owed to our privileged relationship with Canadian Tire, our majority unitholder and more significant tenant. In an era of retail disruption, the Canadian Tire brand, nearly 100 years old, continues to grow and evolve with Canadians, competing effectively in an emerging multichannel world, building on one of the best located and most convenient bricks-and-mortar store networks in the country.Let me give you a flavor for what we see from the REIT's perspective. Since our IPO, we have completed or have underway the development of the 11 replacement Canadian Tire stores and 5 incremental stores. The replacements have been to larger on-concept stores in proven markets and the incremental stores have been in high-growth markets across the country. One of the replacement stores is in Grand Prairie, Alberta, which just opened in Q1, and as Kevin reported, is the largest 1-level Canadian Tire store in the country. Two of the replacement projects will be stores relocated to larger vacant target boxes in multi-tenant assets we acquired from others provided both -- providing both growth opportunities for the retailer and value-add opportunities for the REIT.In addition to the new builds and redevelopments, we have expanded over 40 Canadian Tire stores in our portfolio. This is just Canadian Tire's development with CT REIT and doesn't include the company's development with third parties.Canadian Tire, unlike many in retail to burdened by debt and lack of imagination, has been executing a program of investment in digital technology and in keeping its strong network up to date and relevant for customers. I love the fact that CTC considers its websites, e-commerce business and consumer apps as digital properties, extending the concept of real estate beyond bricks-and-mortar in a multichannel world. One of the most visited websites in the country works together with the high-quality network of stores, located close to customers across the country, allowing Canadians to shop the way they want, whether in-store, online for pickup in-store or online for delivery to home, Canadian Tire's multichannel strategy together with outstanding merchandising is delivering for Canadians.Winning companies thrive in times of disruption and as the headlines scream, retail apocalypse, Canadian Tire keeps growing, and we at CT REIT grow together with it. Including the investments I just mentioned, we have, since IPO, acquired, developed or have in development almost 10 million square feet of GLA and have committed approximately $1.8 billion pursuing a strategy linked to Canadian Tire store network, supply chain and office requirements.As many in the REIT sector turn to mixed-use and high-rise development, recycling capital out of secondary markets to invest in high-cost urban markets, we're pursuing a different path. A path that provides visibility to predictable and growing results in a business model less challenging and risky to execute. While we have embedded in our portfolio high-quality urban assets and pursue select value-add multi-tenant opportunities, as our path diverges from our peers, CT REIT increasingly emerges as Canada's premier net lease REIT, a space we're more than happy to occupy.For our investors, this means continued focus on our key competitive advantage, our relationship with Canadian Tire to deliver reliable, durable and growing results.And now, operator, I'll turn the call back to you for any questions from our listeners.

[Operator]

[Operator Instructions] And we do have first question from Matt Logan from RBC Capital Markets.

[Matt Logan, Senior Associate]

In terms of Canadian Tire's digital initiatives, can you talk about your distribution center portfolio? And how the REIT is helping Canadian Tire adapt its supply chain?

[Kenneth Silver, President, CEO & Trustee]

Matt, it's Ken. As we demonstrated with the investments we've made so far, particularly the investment we made in what was formerly Sears Canada distribution center, we're obviously more than happy to provide space to Canadian Tire for them to use. How they use the space between direct-to-store and direct-to-customer delivery or how they can sell their e-commerce strategy, we kind of leave it to them. But suffice to say that we try to stay very close to them on all elements of their real estate requirements, whether it's retail, whether it's supply chain and whether it's their office needs.

[Matt Logan, Senior Associate]

And as you guys redevelop some of the former Canadian Tire stores for other purposes, can you talk about maybe what makes the Canadian Tire footprint ideal for other users?

[Kenneth Silver, President, CEO & Trustee]

Sure. One of the things that, I guess -- a couple of things that distinguish the Canadian Tire buildings relative to some of our peers in the big box retail industry is, firstly, our stores were typically smaller on average than some of the larger players. And the dimensions of the stores were also a little bit different, so they weren't as deep as a Home Depot box or a Walmart box. And that lends themselves to either dividing them up for multi-tenants or allowing them to be recycled for tenants who don't need quite as much space like a supermarket.

[Matt Logan, Senior Associate]

Appreciate the color. And in terms of some of your secondary market acquisitions as your peers sell assets, can you talk what we're seeing in terms of pricing in the market?

[Kevin Salsberg, Senior Vice]

Matt, it's Kevin. I think generally speaking, we're seeing cap rates fairly flat for the most part in secondary markets. It's been an interesting dichotomy to see certain assets trade and certain assets not trade. So I think where vendors can get their pricing, they're happy to transact, and where they don't feel they've been properly rewarded, they -- we've seen them pulling deals. So I think cap rates are holding up, but there is some tension in the bid/ask spread that we're seeing as well.

[Matt Logan, Senior Associate]

But suffice to say, for the types of assets, the REIT owned, pricing is generally holding pretty firm?

[Kevin Salsberg, Senior Vice]

Yes. I think those are mid-market space that's REITs are getting out of, private investors are hopping into where there is a lot of capital chasing, strong covenants, long-term leases, management-free assets similar to the ones we would own for sure.

[Operator]

The next question is from Sumayya Hussain from CIBC.

[Sumayya Hussain, Associate]

Just to proceed to confirm on the temporary vacancy on tenancy, I guess, at Dufferin Place. Will the NOI contribution in Q2 be similar to what we saw in Q1?

[Lesley Patricia Gibson, Senior VP & CFO]

Sumayya, it's Lesley. CTC occupied the space for 1 month in the first quarter, and we're expecting that CTC will probably occupy for all 3 months in Q2, so there will be a little bit of increase for that in the second quarter.

[Sumayya Hussain, Associate]

Okay. And I think it was about $1 million additional NOI from that tenancy?

[Lesley Patricia Gibson, Senior VP & CFO]

No, no. No, it's less than $100,000 a month.

[Sumayya Hussain, Associate]

$100,000, okay. Great. And I just -- I wanted to touch on to leverage, if that 44%, it's a pretty conservative, but there are a couple of your peers that are even lower, but maybe with slightly different business models. Any thoughts on if you're comfortable where you are right now? Or would you want to see it go even lower?

[Lesley Patricia Gibson, Senior VP & CFO]

Sumayya, I think we're very comfortable where things are right now. I think one thing that perhaps puts us in a different position is the creditworthiness of our tenant in CTC and how they're doing and how we feel about the surety of those cash flows, so perhaps compared to some, we could be higher up in the spectrum, but right now in the area we are in, we're very comfortable.

[Operator]

The next question is from Sam Damiani from TD Securities.

[Sam Damiani, Analyst]

Just on the balance sheet. Could you just confirm or talk about to what extent the Yonge and Eglinton asset has been maybe written up from a very fair value perspective since the original acquisition?

[Lesley Patricia Gibson, Senior VP & CFO]

Sure, Sam, it's Lesley. The asset at Yonge and Eglinton as originally purchased and then a subsequent purchase from air rights has basically been at the acquisition price. There's been no change to sort of the cap rate metrics we've applied to that property since we've acquired it.

[Sam Damiani, Analyst]

And presumably, the NOI coming off the property is pretty stable though...

[Lesley Patricia Gibson, Senior VP & CFO]

Yes. It is. The NOI has gotten a little bit better or marginally better since the initial acquisition, but relatively stable.

[Sam Damiani, Analyst]

And just going over to the Calgary industrial properties. Obviously, nice to have some temporary income. But what is the pipeline of discussions looking like for long-term leasing of that space?

[Kevin Salsberg, Senior Vice]

Sam, it's Kevin. So unfortunately, we don't have a concrete update for you on the leasing progress. More qualitatively, I can say we've had several groups at the table who I can say still may materialize. We had what I described as advanced discussions with. But all of those groups have been a little hesitant to pull the trigger while they wait for a little bit more clarity on the State of the Alberta economy generally speaking. So there's interest, but from the industrial players, the 3PL groups, the groups who are servicing the oil and gas fields, we're seeing a little bit of hesitation in terms of actually pulling the trigger so far.

[Sam Damiani, Analyst]

Okay. And just finally, on the -- this deal's DC that is on Canadian Tire's balance sheet, any update there, any progress since last quarter?

[Kenneth Silver, President, CEO & Trustee]

Sam, it's Ken. There is no progress really to report on that. We continue to have discussions with Canadian Tire around potential build form on a property and how it might be used, but nothing concrete to report at this moment.

[Sam Damiani, Analyst]

But they've confirmed that they do not need that site for their purposes anymore?

[Kenneth Silver, President, CEO & Trustee]

At the moment, yes.

[Operator]

The next question is from Jenny Ma from BMO Capital Markets.

[Jenny Ma, Analyst]

This question is probably for Lesley. I just wanted to make sure that the contribution from acquisitions and developments in 2019 that you guys break out in the MD&A ties to the $81 million of total investments for Q1? Sorry, the $360,000 on Page 36, I just want to make sure that was judged from the bucket that's being described in Page 10, the $81 million, the acquisitions and the redevelopments that were done during the quarter.

[Lesley Patricia Gibson, Senior VP & CFO]

[indiscernible], Jenny, hang on. Yes, so Jenny, just looking through the list of properties, yes, all those ones are either new acquisitions or assets that have been moved from property development into investment property in the third quarter and they should be in those 2018-2019 sort of net operating, but not same-store.

[Jenny Ma, Analyst]

Right, right. So I guess based on that number, $360,000, most of these would have closed, I guess, towards the end of the quarter, so there's probably a bit more contribution coming from that bucket into Q2?

[Lesley Patricia Gibson, Senior VP & CFO]

Yes, you're correct. Some of those stores were truly the last couple of days of March.

[Jenny Ma, Analyst]

Okay. Got you. With regards to -- going back to the question about the secondary market. So your peers have been selling quite a bit. Haven't you guys internally sort of gone through your portfolio to see if there are some properties that you might consider to be noncore so to speak or have maxed out their growth potential and you would potentially look at selling? Or do you view these sort of because they're Canadian Tire anchored and occupied that they are all core to the CT REIT portfolio?

[Kenneth Silver, President, CEO & Trustee]

Jenny, it's Ken. I'll never say never, but we currently have no plans to divest certainly Canadian Tire anchor properties in secondary markets. There are circumstances where we might see Canadian Tire move out of an existing store into a newly built store. At the time of the IPO, we had identified a number of stores that we didn't think would meet Canadian Tire's long-term requirements and we did not vend those into the REIT at that time. This new store -- the old store in Grande Prairie was an example, so Canadian Tire still owns that. But we now own the new stores. So it's possible that we might sell a property that Canadian Tire's moved out of because we don't want to reinvest in that building in that specific market, but it's really a case-by-case basis as opposed to some sort of overarching strategy that we want to recycle capital out to secondary markets.

[Jenny Ma, Analyst]

Okay. That makes sense. With regards to -- hold on 1 second. Let's see here. I'll have to circle back with you on that. I'll get back to you on it. I just lost my train of thought there.

[Kenneth Silver, President, CEO & Trustee]

Okay.

[Operator]

The next question is from Pammi Bir from Scotia Capital.

[Pammi Bir, Analyst]

Just -- not to beat a dead horse here, but coming back to 11 Dufferin, is there a possibility that Canadian Tire might have some interest in permanently occupying that space or can you convince them?

[Kevin Salsberg, Senior Vice]

Well, we can certainly try. It's Kevin speaking, Pammi. As of right now, there's no indication there the space beyond Q2. Obviously, should that change, we can update you at that time.

[Pammi Bir, Analyst]

I guess, maybe just sticking with that, are there any challenges or maybe unique features that make this property maybe a bit more difficult to lease at all?

[Kevin Salsberg, Senior Vice]

No. Not specifically. I mean the depth of the building is good. It's typically 28 feet clear high, got base, got some additional land next to it. It's near CN rail yards and highway infrastructure. So it's actually highly desirable. I think it's more the State of the Calgary industrial market as there's some new supply coming on stream over the next few quarters. Probably a different type of asset, newer inventory, higher rent, so we actually like our positioning, it's just waiting for the right tenant.

[Pammi Bir, Analyst]

Right. That was actually one of my questions, I guess, on the new supply side. But maybe just switching gears. If you look at the balance of the year from an investment standpoint, how do you -- how much do you expect to spend on developments per, say again, through 2019 versus transferred to income-producing?

[Kenneth Silver, President, CEO & Trustee]

Pammi, it's Ken. Well, we've gotten pretty good visibility obviously to -- as laid out in the MD&A as to when we expect some of the properties in the development pipeline to transfer income-producing, so we're pretty clear on that. With respect to -- we continue to work with Canadian Tire, they develop their pipeline of new projects. Above and beyond that if there's an acquisition that we'd like to move on, as we said before, that tends to be a little bit more opportunistic, we've been, frankly, I think, relatively patient with regard to what's been on the market and what we're prepared to bid on.

[Pammi Bir, Analyst]

Okay. Just one last one. If you look at what Canadian Tire has left in terms of their retained portfolio, you gave us some color with respect to back at the IPO and some of the assets that they kept? Do you have us a rough sense of how much of that could be ready to be vended into the REIT over the next 12 months?

[Kenneth Silver, President, CEO & Trustee]

It's Ken. No. We've invested or moving a few of the project -- a couple of stores in this year so far. I think, frankly we kind of view the inventory of properties that Canadian Tire still owns frankly as inventory, that-- we'll tap into that is the source of growth depending on other things that we see happening.

[Operator]

The next question is from Tal Woolley from National Bank Financial.

[Tal Woolley, Research Analyst]

I just wanted to ask -- go back to the secondary market question. Do you have -- in your conversations with Tire, have you had -- heard any concerns about some of those secondary market locations not being able to sort of support the 1.5% rent increases over the long term?

[Kenneth Silver, President, CEO & Trustee]

Tal, it's Ken. Two things. One is we average 1.5% rate increases across the portfolio, but we actually distribute the -- over the portfolio in different ways, so not every store is 1.5% every year. There are some that are lower. And at that time of the IPO, we kind of were reflecting what we thought of as the potential growth rates within that market. What I can tell you is since the IPO, frankly, I think, Canadian Tire's done a great job competing in the retail market and if you look at same-store sales growth, it has been quite robust for the past 5 years or so. So we're quite comfortable with really where Canadian Tire has been. If anything, if there's any pressure, it's that Canadian Tire is outgrowing stores. And as I mentioned in my script, I mean, we've expanded 40 stores so far, and Canadian Tire kind of gets to the point where when they see sort of store product to be kind of bumping up into certain levels, then they'll look to expand the stores. And I can tell you that those store expansions and that pressure has come across as much in secondary markets as anywhere. So we don't see any concerns.

[Operator]

Thank you. There are no further questions at this time. So I will turn the call over to Ken Silver, CEO, for any closing remarks.

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator, and thank you all for joining us today. We expect our second quarter results will be released the last week of July. We look forward to speaking with you then.