CT Real Estate Investment Trust

TSX:CRT.UN

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, my name is Julian, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's Second Quarter's Earnings Results Conference Call. [Operator Instructions] The speakers on the call today are Ken Silver, Chief Executive Officer of CT REIT; Louis Forbes, 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 fact -- risk factor, which are included in their 2017 MD&A and AIF, which can be found on CT REIT's website and on SEDAR. I would now like to turn the meeting over to Mr. Ken Silver, Chief Executive Officer of CT REIT. Please go ahead, Mr. Silver.

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator. And good morning, everyone. We're very pleased to welcome you to CT REIT's second quarter 2018 investor conference call and to share with you the results of another strong quarter. I trust our audience has been enjoying the great summer weather, and I'll keep my comments brief so you can get back out and enjoy it or go to your next call if you're an analyst. All the hallmarks of CT REIT were once again on display in Q2. Attractive growth in AFFO per unit, a strong balance sheet and conservative financial management, disciplined and low-risk investing and a well-considered and long-term view to creating value for unitholders. Executing our strategy delivers attractive results at low risk, and that combination of growth and security remains the focus of our efforts. With that, I will now turn the call over to Kevin Salzburg, our Senior Vice President of real estate to discuss our leasing, investment and development activities. Louis Forbes, our Chief Financial Officer, will then briefly review the financial aspects of the quarter, and I'll wrap up -- I'll wrap things up before turning to call over for questions. Kevin?

[Kevin Salsberg, Senior Vice]

Thanks, Ken, and good morning. As described in yesterday's release, we are pleased to announce 4 new projects this quarter for an aggregate total investment of $24 million. These new projects include 2 new Canadian Tire store expansions in Kincardine and Midland, Ontario. The acquisition of land from a third party, which will allow for the expansion of an existing Canadian Tire store in Val-d'Or, Québec, as well as the development of a 34,000 square foot Canadian Tire store in Mt. Forest, Ontario. These investments, when completed, will result in an incremental 120,000 square feet of gross leasable area being added to the portfolio and are expected to earn an average going in cap rate of 6.57%. In the second quarter, we completed the intensification of an existing Canadian Tire store in Listowel, Ontario, and the development of a Canadian Tire store and Canadian Tire Gas plus gas bar in Amos, Québec. Including the completed intensifications, the REIT invested $20.6 million during the quarter and added approximately 67,000 square feet of incremental GLA. Subsequent to quarter end, we completed the vend-in of an existing Canadian Tire store and Canadian Tire Gas plus gas bar in each of Belleville and Gananoque, Ontario. The vend-in of a redeveloped Canadian Tire store in Picton, Ontario, and the vend-in of development land in Grande Prairie, Alberta, where our new Canadian Tire store is expected to be completed by the fourth quarter of 2019. These vend-ins will add roughly 300,000 square feet of incremental GLA, once completed. For clarity, CT REIT acquired the Picton property from a third party subject to a ground lease with Canadian Tire in Q2 2017. And in Q3 2018, the repurchase Canadian Tire's leasehold interest in the property. Canadian Tire had recently redeveloped and intensified this location and has entered into a new lease with the REIT. At the end of the second quarter, CT REIT had 13 properties under development, representing a total committed gross leasable area of 712,500 square feet and a total committed investment of $148.4 million upon completion. As at June 30, 2018, on a committed basis, our portfolio is 98.7% occupied. Canadian Tire corporation represents 92.5% of our annualized base minimum rent and occupies 94.5% of CT REIT's GLA. All of these metrics are relatively unchanged from a year ago. Beyond what was completed during and subsequent to Q2, we continue to make progress as expected on the balance of our development projects as detailed in our latest MD&A. With that, I will turn it over to Louis for a review of our financial results.

[Louis Marie Forbes, Senior VP & CFO]

Thanks, Kevin. In Q2 2018, we reported FFO per unit of $0.292 as compared to $0.283 per unit in Q2 of 2017, an increase of 3.2%. AFFO per unit was $0.241 as compared to $0.231 in the comparable period, representing a 4.3% growth rate. That's on -- operating income was $86.3 million, increasing 7.6% over the $80.2 million of NOI reported for Q2 2017. This growth was primarily driven by acquisitions of income-producing properties, the completion of properties, which were under development in the prior year and contractual annual rent escalations. The same store growth rate of 1.8% and same property growth of 2.0% were driven by the average annual rent escalations of 1.5%, contained within the Canadian Tire store and CTC's distribution center leases, which are generally effective January 1, the recovery of capital expenditures and the related interest earned. Also included in these amounts were certain rent and expense recoveries from Sears that we had previously written off. G&A expenses as a percentage of property revenue were relatively flat at 2.3% versus 2.2% in Q2 of 2017. G&A expenses increased 14.1% versus Q2 2017, primarily due to increased personnel expenses, related to the variable components of compensation awards and increased headcount. Interest expense increased by $2.4 million or 10% compared to Q2 of the prior year. This increase was primarily due to increased interest on the debentures issued in June 2017 and February 2018. Partially offset by savings resulting from the redemption of series 10 to 15, Class C LP Units in May 2017, savings from reduced utilization of the bank credit facility, and increased interest capitalization on development projects during 2018. The net effect is that the REIT has replaced inexpensive short-term debt with longer-term fixed-rate debt, which has served to reduce CT REIT's interest rate and refinancing risks. The REIT recorded a fair value adjustment of $12 million for the second quarter of 2018, a decrease of $2.6 million versus Q2 2017. As you may recall, Q2 of 2017 included a gain in value of an industrial property, located in Québec, primarily due to a slight decrease in the cap rate for this property, there were no similar gains recorded during Q2 2018. With respect to the balance sheet, we continue to maintain a strong financial position. At June 30, the REIT's indebtedness ratio was 46.2%, a slight improvement over the 46.7% reported last quarter. We have approximately $280 million available on our credit facility as well as approximately $2 million of cash, which puts our balance sheet in a strong and liquid position. Debt as compared to earnings before interest taxes and fair value adjustments was 7.4x, lower than the 7.62x reported in Q4 2017, and primarily related to EBIT fair value growth exceeding the growth of CT REIT's total debt. As of June 30, 2.13% of the REIT's debt bears interest at floating rates compared to 8.53% at December 31. The reduction is related to the planned repayment of the CTC bridge facility and repayments towards the bank credit facility. Also as at June 30, 333 of the REIT's assets were not encumbered, representing approximately $5.5 billion or 98% of our assets. The interest coverage ratio was 3.39x in the second quarter, which was slightly lower compared to the prior year value of 3.5x. The decrease, which we do not [ use ] material is mostly the result of interest and financing charges, increasing at a rate larger than that of income before interest, taxes and fair value adjustments. Our AFFO payout ratio this quarter was consistent with Q2 2017 at 76%. I would also like to take a minute to speak to the trend in our book value per unit. At June 30, 2018, the book value per unit was $13.71, representing 2.4% growth over the book value of $13.39 reported at the end of Q4 of 2017. The following are contributing factors to this increase: A higher value for the income producing properties due to ongoing growth and the cash flow resulting from the annual rent increase; ongoing recoverable CapEx spend and retained AFFO. On a trailing basis, combining distributions and book value per unit growth CT REIT has, since IPO, consistently delivered a total annual return in excess of 10%. With that, I will turn it back to Ken.

[Kenneth Silver, President, CEO & Trustee]

Thanks, Louis. To wrap things up, we're delighted with the results of another solid quarter. Our prospects for growth, whether with CTC or otherwise, remain very attractive, and we look forward to sharing our progress with you in the quarters and years to come. And now operator, I'll turn the call back to you for any questions from our listeners.

[Operator]

[Operator Instructions] Our first question is Sumayya Hussain from CIBC.

[Sumayya Hussain, Associate]

Just on the new vend-ins announced this quarter, can you tell us a little bit more about the Mount Forest market and what you saw there that you liked?

[Kenneth Silver, President, CEO & Trustee]

I'm sorry, Sumayya. What -- can you repeat the question?

[Sumayya Hussain, Associate]

Yes. Just on the vend-ins announced with a quarter, the Mount Forest market and what dynamics of that were appealing to you?

[Kenneth Silver, President, CEO & Trustee]

Okay. Thank you, sorry about that. So in Mount Forest, Canadian Tire had an old facility in that town. It'd been there for many, many years. And it's -- typical of the kind of market where Canadian Tire can do very well and has obviously a very strong brand equity and franchise. So it was simply an opportunity to move the Canadian Tire facility into a better location in a much better facility, much larger and to move from a lease with an unrelated third party to a property owned by the REIT.

[Sumayya Hussain, Associate]

Okay. And just -- you guys had mentioned a bit of an update to your external evaluation process. Can you just expand on the change and the rationale there?

[Louis Marie Forbes, Senior VP & CFO]

Sure. Sumayya, it was really a productivity initiative. We had not seen, over the 4.5 years that we've been public, large changes in values, in the small value assets, and we are continuing under the new proposed process to get data points that will inform the internal evaluations of those assets the same way we have all along us. So we just thought it was an efficiency move.

[Operator]

Our next question is from Jenny Ma from BMO capital markets.

[Jenny Ma, Analyst]

Louis, a question about the additional recoveries coming from Sears, could you quantify what that impact was in Q2 and confirm that all those loose ends coming from Sears have been settled as of Q2 with regard to the recoveries? And it looks like there was an impact on same -- sorry, straight-line rent as well possibly from the lease up to Canadian Tire at the DC space.

[Louis Marie Forbes, Senior VP & CFO]

Okay. All good questions, Jenny, observant. With respect to the Sears impact on the second quarter NOI, it was approximately a $300,000 positive impact. We had certain accounts receivable on the books during our first quarter, and at the end of the first quarter we took full provisions and gains for those receivables and managed to collect $300,000 during the second quarter. So that's the first part of your question. The second part of your question is, the Sears process as you may understand it from the newspapers continues to run its due course, and we still have certain types of claims within that process, but we wouldn't hold out any hope for anything further happening on that front. Then your third question, our -- both straight-line rent accounting, you're absolutely right, the new lease with Canadian Tire at the Calgary DC did contribute to an increased component of the straight-line rent -- revenues in Q2.

[Jenny Ma, Analyst]

So is -- so I want to confirm if the timelines were still on track with what you guided last quarter as far as the lease up at the DCs. Like has there been any incremental lease up in the smaller center? Or is it pretty much still where we were when we last spoke in May?

[Kevin Salsberg, Senior Vice]

Jenny, it's Kevin. We have made progress. We don't really have anything to say specifically right now, but the prospective interest from tenants has been relatively strong, and we are continuing to work our way towards getting it leased. So nothing to say now but hopefully soon.

[Jenny Ma, Analyst]

Okay. So I guess the way to think about the 2 line items I referred to earlier was, there was a positive $300,000 impact on the recoveries in Q2 that probably won't recur in Q3 barring any other settlements I guess. And then the straight-line rent is a reasonable run rate going forward?

[Louis Marie Forbes, Senior VP & CFO]

On the straight-line rent -- and this is very small. But we live to talk about small numbers. The CTC lease commencement date was not April 1, it was mid-quarter, May 1. So there is a 2-month impact in Q2, but there will be a 3-month impact in Q3. So -- but other than that, yes.

[Jenny Ma, Analyst]

Okay. And then any other one-time items we should be aware of in the numbers?

[Louis Marie Forbes, Senior VP & CFO]

No.

[Operator]

The following question will be from the Sam Damiani from TD Securities.

[Sam Damiani, Analyst]

Jenny ran off a lot of questions that I was going to ask. The quarter was unusually strong. Usually, CT REIT is very predictable, and I think you beat The Street by a penny, which -- we're just trying to figure out where that variance is. And Louis you mentioned $300,000 from Sears, was that a negative NOI impact in Q1? Such that the incremental change in Q2 was actually $600,000?

[Louis Marie Forbes, Senior VP & CFO]

We did record some revenue from Sears in Q1 because they paid us some revenue in Q1. The amount we recorded in Q2 was slightly larger than the amount we recorded in Q1, but not much.

[Sam Damiani, Analyst]

But the gross amount was $300,000, as you said?

[Louis Marie Forbes, Senior VP & CFO]

Right.

[Sam Damiani, Analyst]

Okay. Any progress on further acquisitions, the pace overall has been slowing a little bit, but not to be a -- it's a huge surprise, but just wondering if -- what your outlook is for total investment following for the balance of the year.

[Kenneth Silver, President, CEO & Trustee]

Sam, it's Ken. Nothing has changed in terms of our growth potential or the opportunities we see out there. And I guess we'd expect to see some variance and announcements from quarter-to-quarter or even year-to-year. We continue to have the benefit of the -- of obviously, the healthy organic growth that we've got built into the portfolio of leases with Canadian Tire, and we complement that growth with continuing the vend-in properties, ongoing developments and intensification with CTC and the other banners, third-party acquisitions. I -- some of what we do is ongoing, I mean, the vend-ins and the ongoing developments with CTC anchor developments is relatively predictable, what's less so is the third party acquisitions, which I would call somewhat more opportunistic. So that can lend to the -- or contribute to the lumpiness and -- in our investments.

[Sam Damiani, Analyst]

And what about the Brampton former DC? Any sort of clarity on what the REIT's involvement is in time, at the stage?

[Kenneth Silver, President, CEO & Trustee]

Well, I can tell you that we're very much involved, and we're proceeding with some preliminary planning for the redevelopment of the site and are in discussions with the city of Brampton. There is a municipal process underway at the city of -- a broader municipal process underway in the city of Brampton that impacts the site. But we continue to view this, obviously, this 90-acre site as a very attractive opportunity for us in the future. I'm just not attaching any kind of timeframe to it at this point.

[Sam Damiani, Analyst]

And I think initially when this opportunity arose, it was viewed as primarily a commercial development site. Has that changed at all?

[Kenneth Silver, President, CEO & Trustee]

Well, I think the western part of the site, which is across from the Brampton -- pardon me, the Bramalea GO Station. We would view -- and I think as consistent with the city's perspective that it would be a mix of uses and some intensification on that site. I think, probably a commercial, a retailer or office at that corner. And the balance of the site, we continue to view as ongoing employment uses.

[Unknown Executive]

Industrial.

[Sam Damiani, Analyst]

So no residential particularly on that site at this stage?

[Louis Marie Forbes, Senior VP & CFO]

No. I wouldn't say that that's a priority for that site.

[Operator]

The next question is from Michael Smith from RBC capital markets.

[Michael Smith, Analyst]

Most of my questions have been answered. But Ken are you -- we have seen some inflations in cost and -- in development costs. And I'm just wondering if you could comment on how that is affecting you if at all.

[Kenneth Silver, President, CEO & Trustee]

Michael, It's Ken. I think that the inflation that people are talking about in construction is predominantly -- but not exclusively, but predominately in high-rise construction in urban markets, I think that's where it's manifesting itself, so -- the strongest.

[Michael Smith, Analyst]

So basically, given the projects you have on the go and the fact that they're not high rise, you really haven't noticed that much of a change, I guess?

[Kenneth Silver, President, CEO & Trustee]

Well, I mean there is a -- there's always -- construction people will only tell you their costs go up. We see that, but I wouldn't say that it's a problem.

[Michael Smith, Analyst]

Okay. Great. And any updates on your head office?

[Kenneth Silver, President, CEO & Trustee]

Well, generally, I could tell you that we're seeing some good progress on the Canada Square project. Earlier this year, the board of the TTC and Toronto City Council, approved the terms of a new and amended ground lease for the property that will facilitate the redevelopment. So obviously that was a pretty key step in the process. I'd also tell you that preliminary design and concept planning is more or less complete and is moving to the next stage of design development. So I don't have anything to announce at this point other than to say, generally, we're pleased with the progress on the project.

[Michael Smith, Analyst]

So that was a -- obviously, a big milestone with that ground lease.

[Kenneth Silver, President, CEO & Trustee]

Yes. I mean, I think we were, obviously, always optimistic that we would have a successful outcome in -- with the TTC in the city. I mean certainly there's a great deal of alignment in seeing something happen on the site. So -- but yes, I would say that's an important step.

[Operator]

The Next question is come from Pammi Bir from Scotia capital.

[Pammi Bir, Analyst]

Just maybe building on that last question on Canada Square. Can you comment on what perhaps the potential density mix might look like?

[Kenneth Silver, President, CEO & Trustee]

I'd say, upon the -- it's going to be a mixed-use development. So there's going to be an office component, retail component and residential. But it'll be developed in variety of phases over a period of years.

[Pammi Bir, Analyst]

And if you had to, I guess, maybe just potentially estimate of -- perhaps when that process might start in terms of development. Any additional thoughts there?

[Kenneth Silver, President, CEO & Trustee]

Well, as I said before, the redevelopment of the property is, certainly -- I guess, influence might be an understatement by the development of the Crosstown LRT. So we need that to reach a certain point in the development so that we can get access to lands to kick-start the development. So I'm not anticipating a shovel in the ground, say before the end of 2021.

[Pammi Bir, Analyst]

Okay. That's definitely helpful. And Louis, maybe just, going back to some of the comments from last quarter, I think you'd mentioned that there was an expectation for about $750,000 drop in that operating income for the Calgary distribution space as it transitioned from Sears to Canadian Tire. So again, maybe just to clarify maybe close the loop here, the only adjustment then going forward is really just this $300,000 recovery or the onetime recovery in Q2? And any sort of, sorry, remaining lease above the Canadian Tire vacancy.

[Louis Marie Forbes, Senior VP & CFO]

Yes. And maybe restating what you've said. I did say, we expected a $750,000 drop, and that has been -- and that amount has been amended by the $300,000 surprise that we mentioned earlier in the call. And you're right, I mean Canadian Tire's occupancy of 25 Dufferin started May 1, so we'll have a full 3 months contribution next quarter, so that will help. And then it's subject to what Kevin has commented on in terms of the back filing at 11 Dufferin. That will be further positive news presumably at some point in the future.

[Pammi Bir, Analyst]

Got it. Just one last one. In terms of the post quarter end investments that you mentioned, what was the estimated total value of those investments and the estimated cap rate?

[Kenneth Silver, President, CEO & Trustee]

We might have to circle back with you on that.

[Operator]

[Operator Instructions] The next question will be from Tal Woolley from National Bank Financial.

[Tal Woolley, Research Analyst]

I just wanted to ask quickly about the size of the retail development pipeline. You've been managing to take on new projects with a complete thumb successfully. Is there any chance that you could take on more, like take that $150 million and increase that? Is there any thought to that going forward or are you still very much limited by sort of what Tire would like to do in that regard?

[Kenneth Silver, President, CEO & Trustee]

Well, we're -- it's Ken speaking. We're not limited in any way. We're selective in what we're doing, and we work very closely with Canadian Tire in terms of what their plans are for their network. We -- as you can see by some of our announcements, we're well into planning for 2020. In terms of the pipeline of projects that Canadian Tire hopes to deliver to its operators. So I'm not sure if that answers your question.

[Tal Woolley, Research Analyst]

That's fair. I was just trying to get a sense of if there -- given how successful it has been whether there's considering -- just trying to take on more at the same time, but it does sound like -- it is sort of contingent on what Tire's development plans are, is that fair?

[Kenneth Silver, President, CEO & Trustee]

Yes, that's right. I'd say, clearly, that's a very attractive area of growth for us is to have that relationship with an anchor tenant like Canadian Tire and develop new store properties for them. So that's clearly a priority for us as well as we look for other opportunities in the marketplace where we can add value.

[Pammi Bir, Analyst]

Yes. I guess as my next question, we've seen a lot of the other retail REITs really trying to hone their focus on major market exposure and there's a lot of assets in the market, in secondary markets. And if I just think Tire's sort of retail heritage, like, that's -- those are often markets where they're incredibly strong. And they account for a disproportionate amount of retail activity. You're 5 years out from the IPO now, have you had a conversation with Tire about maybe doing more in these secondary markets, but maybe not with them as the -- sort of like lead partner, but maybe thinking about doing more in some of these small markets. Is that somewhere where you could have an advantage maybe do a better job than some of the people that are out there?

[Kenneth Silver, President, CEO & Trustee]

Well, it's very observant, because we do feel that we do have an advantage in those markets because of the relationship with Canadian Tire and because they're such a strong tenant and operator in those kind of markets. And our ability to work with Canadian Tire and identify secondary markets where there is attractive household and income growth is, I do believe, a competitive advantage for us. And you can see that in our investing program in some of the markets where we -- pardon me, have chosen to do greenfield development or replace stores. When Canadian Tire is doing that, it's a signal that they're doing very well, if they need a larger store or want incremental development.

[Operator]

The next question is from the Sam Damiani from TD Securities.

[Sam Damiani, Analyst]

Well, I was just going to ask a similar question, but more specifically about diversification away from Canadian Tire. Your closest peers in the REIT world have pursued some meaningful diversification away from their -- their sort of major tenant relationships. I'm just wondering if that in and of itself represents a desired goal either in the medium or long-term for the REIT.

[Kenneth Silver, President, CEO & Trustee]

Sam, it's Ken. I think there is 2 ways to answer that question. One is, when we view the -- I would say our appreciation of the benefits of the relationship with Canadian Tire delivers to the REIT and to our unitholders is clear and to us with the passage of time, the ability to leverage that relationship and create value and do it at a relatively -- in a relatively low-risk way, is clearly our competitive advantage. And leveraging that relationship, creating value in markets both urban and secondary is a great opportunity for us, particularly to the extent that some are either exiting or overlooking secondary markets. So we can we can really create value there in a low-risk way. The practical aspects of diversification is, I used to joke that we'd have to do $5 billion of non-Canadian Tire to diversify away from Canadian Tire, and that we wouldn't be able to find $5 billion of -- to invest in, and then if we did people would still think we were the Canadian Tire REIT. So my perspective is, diversification from Canadian Tire is neither desirable nor realistic.

[Operator]

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

[Kenneth Silver, President, CEO & Trustee]

Thank you, everybody, for joining us this morning. We expect our results to be released the first week of November, and we look forward to talking with you then.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you all for your participation.