CT Real Estate Investment Trust

TSX:CRT.UN

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, my name is Valerie, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's Fourth 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 would 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 morning, everyone. We're very pleased to welcome you to CT REIT's Fourth Quarter 2018 Investor Conference Call. Our strong results in Q4 and for the full year 2018 once again point to the attractiveness of our business model and our focused execution grounded in a strategic relationship with Canadian Tire, one of Canada's leading brands. Our continued and reliable growth is particularly attractive when considered in the context of our risk profile, given our high occupancy, minimal lease turnover, our low-risk development and construction activities and the quality and resiliency of our balance sheet and financial metrics.Our goal has been for CT REIT to deliver in all conditions. And we're delighted that 2018 contributed once again to that track record. Our new CFO, Lesley Gibson, who we're delighted to have on the team and to welcome to her first call, will take you through our financial results in a few moments.In addition to those strong results, 2018 also saw some important milestones, including our fifth dividend increase in the 5-year since our IPO. While none of us here may be aristocrats in life, we're happy to at least now consider ourselves like a dividend aristocrat. Another milestone was our first equity offering from treasury, which coupled with a secondary offering from CTC, increased our float by over 2/3.The single most consistent piece of feedback from investors since our IPO was about the size of our float. So together with CTC, we were delighted to be able to make significant progress on this front. In a moment, our SVP, Real Estate, Kevin Salsberg, will speak to our investment activities. In keeping with our strategic focus, we seek to leverage our relationship with Canadian Tire to create value in ways not available to others or that others overlook, and our recent investment in Niagara Falls is a good example.With our understanding of Canadian Tire's store network and real estate strategy, we can deliver a win for the retailer and its customers as well as for the REIT by backfilling of vacant Target box with a larger, better located Canadian Tire store. With a long-term lease commitment and annual rent escalations in place with Canadian Tire, this is the kind of attractive, low-risk development, which reflects the structural advantages of being related to one of Canada's strongest anchor tenants.As we look ahead, we continue to see potential in leveraging these advantages and are positioning ourselves to strengthen our capabilities. In 2019, we'll complete our property management insourcing project providing us with better and more efficient resources to manage our growing multi-tenant portfolio.With that, I'll turn things over to Kevin to provide an update on our investing activities and operations. Kevin?

[Kevin Salsberg, Senior Vice]

Thanks, Ken, and good morning. As highlighted in our press release yesterday, we are pleased to announce 3 new investments this quarter, totaling $45 million. These new projects include a third-party acquisition of a Canadian Tire store in Canmore, Alberta; a third-party acquisition of a multi-tenant property in Niagara Falls, Ontario, where we intend to redevelop a vacant former Target box for a new Canadian Tire store as Ken mentioned; and the acquisition of land from a third-party to facilitate the planned expansion of an existing REIT-owned Canadian Tire store in Yarmouth, Nova Scotia. These 3 investments represent approximately 297,000 square feet of incremental gross leasable area and are expected to earn an average going-in cap rate of 6.8%. The redevelopment and expansion projects are both expected to be completed in the second quarter of 2020.In the fourth quarter, we invested $29 million on previously announced investments, which included the acquisition of a Canadian Tire Gas+ gas bar from a third-party in Saint-Hyacinthe, Québec; the intensification of 2 Canadian Tire stores in Winkler, Manitoba and St. Thomas, Ontario; and the redevelopment of a previously acquired redundant Canadian Tire store in Sudbury, Ontario. The completion of these projects added approximately 110,000 square feet of incremental GLA in the quarter.In addition, during 2018, we completed the development of 2 freestanding buildings comprised of 5,150 square feet of GLA and 3 land leases for a total investment of $4.5 million at an average cap rate of 8.7%. These developments took place at our existing retail properties in Ancaster, Dunnville and Waterloo, Ontario, and Swift Current, Saskatchewan. These new retail units are a mix of third-party and Canadian Tire Gas+ gas bar tenancies.Highlighting the full year activity, CT REIT acquired, intensified, developed or redeveloped a total of 12 properties, representing over 680,000 square feet of gross leasable area and a total investment of approximately $142 million.At the end of the fourth quarter, CT REIT had 21 properties under development, representing a total gross leasable area of roughly 1.5 million square feet of GLA, and a total committed investment of approximately $256 million upon completion.As of December 31, 2018, the REIT's occupancy rate was 98.7%, virtually unchanged compared to 98.6% 1 year ago. Of this, Canadian Tire Corporation represents 94.4% of total GLA and 92.7% of annualized minimum rent. All these metrics are relatively unchanged from a year ago.Finally, as discussed last quarter, we are continuing the implementation of the new ERP system as part of our property management insourcing initiative, which is expected to be in place by mid-2019, and we are pleased with the project's progress at this time.With that, I will turn it over to Lesley for a review of our financial results.

[Lesley Patricia Gibson, Senior VP & CFO]

Thanks to both Ken and Kevin for their comments and introduction. As this is my first official quarter as the CFO of the REIT, I want to make a few comments before I address the financial results. Firstly to thank Louis Forbes for his contribution to CT REIT and as a mentor to me over the last 15 years in my career. Also to Ken, Kevin, and all the members of both the CT REIT and the Canadian Tire team for the generous welcome I have experienced over the past 4 months. My transition into this role has been seamless with the support I have received.Now turning to our financial performance. In Q4 2018, we reported FFO per unit of $0.286 as compared to $0.283 per unit in Q4 2017, an increase of 1.1%. Additionally, for the full year 2018, we reported FFO per unit of $1.14 as compared to the $1.12 per unit in 2017, an increase of 1.8%. Our results demonstrate continued predictable growth with AFFO per unit of $0.239 compared to $0.232 for the fourth quarter of 2017, representing a 3% growth rate. For the full year 2018, we reported AFFO per unit of $0.954 compared to $0.919 per unit of 2017, an increase of 3.8%. Additionally, after the -- after normalizing for both CFO transition and insourcing project costs, AFFO for Q4 was $0.245 or 5.6% higher than Q4 2017, and full year normalized AFFO per unit is $0.962 or 4.6% higher versus prior year. The AFFO payout is consistent with prior years at a rate of 76%.Net operating income for the fourth quarter and full year was $88.0 million and $345.5 million, respectively, increasing 7.4% and 7.2% over reported Q4 and full year 2017. This growth was primarily driven by acquisitions of income-producing properties and the completion of properties, which were under development in the prior year.The same-store growth of 2.5% and same-property growth of 2.9% were driven by the annual rent escalations of 1.5% contained within most of the Canadian Tire store leases and the CTC distribution center leases, which are generally effective January 1, the recovery of capital expenditures and the related interest earned. The balance of the difference between the same-store and same-property growth is due to completed intensification activities undertaken on same properties. The positive contributions were partially offset by the impacts of the changes in tenancies at 11 and 25 Dufferin Place in Calgary.G&A expenses as a percentage of property revenue were 2.9%, an increase over the 2.4% reported at Q4 2017. This increase was primarily driven by increased personnel expenses due to CFO transition costs and increases in consulting and service agreement costs related to the new ERP that CT REIT expects to implement in 2019, and partially offset by decreased compensation costs and trustee fees due to their fair value adjustment on unit-based awards.With respect to the insourcing project, costs incurred at Q4 are consistent with the amount we shared with you in Q3. As mentioned before, the cost will continue to be incurred throughout the first half of 2019. As of December 31, 2018, the REIT's indebtedness ratio was 45.1%, a decrease compared to the indebtedness ratio as of December 31, 2017, primarily due to CT REIT's 2018 acquisition, intensification and development activities and fair value adjustments made to its investment property portfolio.We are pleased with the solid and liquid position of the balance sheet, and we have an approximately $288 million available through our credit facilities as well as cash. In November, CT REIT along with CTC completed a joint equity offering on aggregate 21,115,000 units. As a result of the offering, CTC now holds a 76.2% effective interest in CT REIT and continues to indirectly own all of the Class C and Class B limited partnership units.CT REIT benefited from the transaction with enhanced trading liquidity for all CT REIT unitholders. We are pleased with the positive impact the equity offering has had on our float as we head into 2019. Since coming off restriction and through February 8, our average daily trading volume is 4.6x higher than it was in fiscal 2018, prior to the announcement of the equity offering.As of December 31, 2018, 2% of the REIT's debt bears interest at floating rates compared to 8.5% at December 31 in the prior year. CT REIT variable rate debt to total indebtedness ratio decreased primarily due to the proceeds of the new debenture offering being used to reduce borrowings drawn on the variable credit rate facilities in 2018.CT REIT's total indebtedness to earnings before interest, taxes and fair value ratio as of December 31, 2018, was 7.31x, a decrease as compared to the 7.62x total indebtedness to EBITDA at the ratio at December 31, 2017, primarily due to the growth of EBITDA fair value exceeding the growth of CT REIT's total indebtedness. The growth in EBITDA fair value was primarily due to increased NOI as mentioned earlier. Net interest expense for Q4 of 2018 increased by $1.7 million or 6.8% compared to Q4 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 10-15 Class C LP Units in May 2017, savings from reduced utilization of the bank credit facility and increased capitalization on development projects during 2018. The net effect is that the REIT has replaced inexpensive short-term debt with longer fixed-rate debt, which has served to reduce CT REIT's interest rate and refinancing risks. This coupled with only 1 debt expiring in 2019 being at $37 million mortgage has greatly inflated CT REIT from changes in interest rate.The interest coverage ratio was at 3.3x for the fourth quarter, which is lower compared to the prior year value of 3.46x. The decrease in the interest coverage ratio is primarily due to the growth in interest and other financing charges, exceeding the growth of CT REIT's income before interest, taxes and fair value adjustments.The REIT recorded a smaller increase in its fair value adjustment on investment properties by $25.2 million in the fourth quarter of 2018 compared to the same period in the prior year. The difference is primarily due to the net higher gains in the prior year on the distribution center in Bolton, Ontario.Net income was $74.5 million for the quarter and $300.9 million for the year, down 23.3% and 5.2%, respectively, compared to the same periods in the prior year, primarily due to smaller increases in the fair value adjustment and investment properties, an increase in net interest and other financing charges, partially offset by an increase in NOI.Distributions per unit in the quarter amounted to $0.182 or 4% higher than the same period in 2017 due to the increase in the annual rate of distribution effective with the first distribution paid in 2018. For the full year, distributions amounted to $0.728 or 4% higher than the same period in 2017.The trend in our book value unit continues to stay course. As at year-end December 2018, the book value per unit was $14.01 versus $13.39 in the prior year, an increase of 4.6%. This growth is primarily due to the net income excluding distributions.With that, I will turn it back to Ken.

[Kenneth Silver, President, CEO & Trustee]

Thanks, Lesley. Given the solid performance and fundamentals of our business, we're entering 2019 with our strategy, growth plans and optimism intact. We look forward to continuing to share those with you in the quarters ahead.Now operator, I'll turn the call back to you for any questions from our listeners.

[Operator]

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

[Sumayya Hussain, Associate]

I just want to touch on the same-property growth in the quarter. It was pretty strong. And if I'm not mistaken, it was your strongest ever. Anything onetime in there at all?

[Lesley Patricia Gibson, Senior VP & CFO]

No. Nothing necessarily onetime. The 2.5% was obviously primarily driven by the CTC leases, and then increased recoveries that is perhaps a little bit more skewed towards the fourth quarter and the interest carry on those. But there was nothing particularly onetime in that number.

[Sumayya Hussain, Associate]

Okay. So just the year-end and the truing up probably the driver there. Great. And I just wanted to get your thoughts on your funding sources for developments and other investments, and you have used multiple sources before. And one of them includes Class B and then just following the recent equity offerings and the progress you guys have made with increasing your float. Do you still anticipate using Class B as one of your funding sources going forward?

[Lesley Patricia Gibson, Senior VP & CFO]

Yes. When we have various resources, we would hit about $50 million or $55 million of retained FFO in any given year. In addition, Class B and Class C units would definitely be something that could factor into our future funding strategies.

[Operator]

Our next question is from Jenny Ma with BMO Capital Markets.

[Jenny Ma, Analyst]

I have a question with regard to the rent uptakes. Now we know the CTC 1.5% has a nice contribution to SP NOI, but could you comment on the lease structure and any rent upticks built into the third-party leases? I know it's a small part of the portfolio, but it's been growing over the years.

[Kevin Salsberg, Senior Vice]

Jenny, it's Kevin. I mean, the third-party portion of our portfolio is so small and the lease rollover in any given year is quite minimal. So I would say, on a whole, it has a very minimal, if negligible impact at all as of right now.

[Jenny Ma, Analyst]

Would they be structured with annual rent upticks similar to CTC, is it more like every 5 years on renewal?

[Kevin Salsberg, Senior Vice]

Typically, every 5 years on renewal.

[Jenny Ma, Analyst]

Okay, got you. And to a similar magnitude, would you say?

[Kevin Salsberg, Senior Vice]

It depends on the margin of the property, but somewhere in the range of probably 5% to 10% is where I would guide you every 5 years.

[Jenny Ma, Analyst]

Yes. Got you. Okay. And then I just picked up a comment on the appraisal of your portfolio. It looks like there was a small change of reducing it from 100% to 80% of the total portfolio. Just wanted a little bit of color on the reason for that change. And what is the threshold for the size of the property that you would subject to the external appraisal?

[Lesley Patricia Gibson, Senior VP & CFO]

Jenny, the rationale was really over 5 years since IPO, the valuation process has refined itself a great deal and there's much more sort of in-depth knowledge of all the markets. And I guess, for us continuing to spend internal and external effort in appraising every very relatively small asset in all the markets wasn't as effective. We continue to have about 80% of the portfolio valued on a rotation of external basis. The threshold for us of not buying it was probably $10 million-or-so. So those very, very small assets wouldn't be subject to valuation and we would use some of the other assets nearby or in the same geographies and then sort of extrapolate to those assets. It wouldn't be subject to the external valuation.

[Operator]

Our next question is from Michael Smith with RBC Capital Markets.

[Michael Smith, Analyst]

Your cap rate on intensifications and developments quite attractive number at 6.8%. Just wondering, is there any pressure either upwards or downwards on that number that you've seen over the last few months?

[Kevin Salsberg, Senior Vice]

Michael, it's Kevin again. In short, no. I think what we've seen in the marketplace and what we're kind of gearing towards is pretty similar to past quarters. We obviously saw a small uptick in the CBE cap rate survey for retail in a couple of different markets. But I would say on a whole, it's remaining pretty flat from what we're seeing.

[Michael Smith, Analyst]

Okay. In your pipeline, is it -- any changes to your -- you're pretty steady in your quarterly announcements of intensification and developments. Any major changes in your pipeline that you would flag for us?

[Kevin Salsberg, Senior Vice]

Nothing that I would flag. I mean, each quarter will have its own ups and downs, but on a whole for the year, I think our expectation is pretty comparable to what we've done in the past.

[Michael Smith, Analyst]

Great. Okay. And just last question, just Ken, I wonder if you could just give us a quick update on Canada Square and maybe highlight your priorities for 2019?

[Kenneth Silver, President, CEO & Trustee]

Sure, Michael. On Canada Square, as I mentioned before, the timing of the development is quite closely tied to the timing of the completion of the LRT on Eglinton. So all the work around the project really relates to that kind of time frame. Now within that context, good progress is being made on all fronts with the city in regard both to discussions on the master plan concept as well as the TTC ground lease and discussions with the potential anchor tenant. And generally, I would say, general themes for the year would be continuing into more of what we've been doing in the past years, leveraging that relationship with Canadian Tire to grow AFFO per unit and balance that with maintaining a strong balance sheet and conservative approach to our financials. With our insourcing project, clearly, we're focusing as well internally in terms of growing productivity and efficiency from our intensifications. We're looking to drive better results out of the portfolio of existing assets that we already own. So a balance of both externally-driven growth through growing the asset base and improving the returns on the assets we already own.

[Operator]

Our next question is from Pammi Bir with Scotia Capital.

[Pammi Bir, Analyst]

Just maybe following up Ken on the -- and Lesley on the insourcing comments, I think, last quarter you mentioned $2 million of total costs for the project, and I think $240,000 was incurred at Q3. So can you just clarify how much was incurred in Q4 and what's left to hit in 2019?

[Lesley Patricia Gibson, Senior VP & CFO]

Pammi, yes, the $240,000 was in Q3, roughly the same amount was spent again in Q4. The costs are ramping up, and there would be about $1 million-more-or-so being spent predominantly over Q1 and Q2 this year.

[Pammi Bir, Analyst]

Okay. That's helpful. And then just one last one. On the Calgary industrial, any update there in terms of releasing progress? When you might have a tenant in place? Or perhaps when that property may start producing some income?

[Kevin Salsberg, Senior Vice]

Pammi, it's Kevin. There are couple of groups that we have been advancing discussions with who have shown interest. We haven't pulled the trigger on anything just yet. I think you can see from the headlines and/or seeing on the sentiment on the ground, Alberta is causing some nerves right now for certain groups. We're not seeing that though operationally at the store level or from the rents we're deriving from our properties there. But we are working to advance the leasing effort. I don't have an update on timing, but we are still optimistic that we'll have something pretty soon.

[Pammi Bir, Analyst]

And optimistic that this should get leased up this year?

[Kevin Salsberg, Senior Vice]

I'm not sure the rent would commence this year, but I think we'll hopefully have a commitment by year-end. That's our goal for sure.

[Pammi Bir, Analyst]

And just on that side, are there any -- would you expect to, I guess, incur any significant repositioning cost to accommodate a tenant? Or is it in pretty good shape that it could easily just move-in ready?

[Kevin Salsberg, Senior Vice]

The building itself is in good shape. There's a couple of items that are probably required for any user, doing lighting or painting, smaller items like that. Any material CapEx would depend on what a user would require. So hard to say right now.

[Operator]

Our next question is from Kyle Stanley with Desjardins Capital.

[Kyle Stanley, Associate]

Just a quick one from me today. Would you be able to disclose how much of the personnel expense during the quarter was attributed to CFO leaving?

[Lesley Patricia Gibson, Senior VP & CFO]

I don't have a split really between the -- we just really have the aggregate for the new CFO on-boarding and the -- some of the change in estimates for the CFO departing. So the aggregate of both those is circa $1 million.

[Operator]

[Operator Instructions] Our next question is from Tal Woolley with National Bank Financial.

[Tal Woolley, Research Analyst]

Just wanted to talk a bit about your planned CapEx development spend. Obviously, it was down fair bit this year because you had far fewer acquisitions, but are you able to give some sort of broad strokes on what you expect to spend on development intensification, CapEx through 2019?

[Kenneth Silver, President, CEO & Trustee]

Sure. Tal, it's Ken. You know these -- our capital investment from year-to-year will -- is generally consistent over a longer period of time, but there will be ups and downs from year-to-year kind of depending on the flow of deals and projects. I would say, generally, obviously, we have very good visibility to the pipeline with Canadian Tire. As well we continue to work away at our intensification projects on the assets that we have in the portfolio. And then, of course, sort of the third-party acquisitions tend to be a little bit more opportunistic and you'll see greater variation in those from year-to-year. But generally, our outlook is quite positive. There is nothing fundamental that's changed in terms of what we see out there in terms of our potential growth agenda.

[Tal Woolley, Research Analyst]

And so you would look at 2018 as that's kind of more of a normal year than what you had seen previously? There were a fair number of like drop downs in the years following the IPO and it's not that they've slowed, but it's just -- it is a little bit less than the one's been in the past.

[Kenneth Silver, President, CEO & Trustee]

Yes, I would say it's probably on the average to low average of our program over the last number of years. We've obviously had some much bigger years and those tended to be more transaction focused. We did have the tail end of our RioCan transaction was part of our investment plan in 2018. So it will depend from year-to-year, but as I said, the prospects really haven't changed.

[Tal Woolley, Research Analyst]

Okay. And then I'm just like historically, Canadian Tire has kind of been 5-, 6-year cycle for store redevelopment. I can't remember the name of the last one, but it was like concept 2020 and then several that came after that. Like in your conversations with Tire, like I would assume, as they start to rollout kind of new generation stores, that's an opportunity for you to play a bigger role in terms of repositioning properties. Can you give me a sense of where you are in that kind of cycle? Or is that not really maybe as relevant going forward?

[Kenneth Silver, President, CEO & Trustee]

I'm not sure it's not relevant. I mean, clearly anything that Canadian Tire does we'll be pretty closely involved with. So it does have the implications for us. I can't speak to the next generation or what thinking Canadian Tire has around what the next real estate-driven retail strategy will be. I leave it to Canadian Tire to speak to that, if and when they are ready to do so. But clearly, we'd be very much involved in that.

[Operator]

Our next question is from Sam Damiani with TD Securities.

[Sam Damiani, Analyst]

Just on the Niagara Falls acquisition. That looks like it's going to be accretive. I'm just curious, with the relocation of -- well, first of all, is the Canadian Tire going in there a relocation? And secondly, the work with Canadian Tire to get that lease going and the approvals with the municipality, is that initiated by yourselves or the vendor?

[Kenneth Silver, President, CEO & Trustee]

That was on -- I thought the discussion was for some time with the vendor knowing obviously what Canadian Tire's plans were for the market. Took a little bit more time to crystallize. And we weren't ready for to be part of the initial tranche that we did with them at the end of '17 and beginning of '18. Canadian Tire saw an opportunity to relocate their store to a better, bigger location. And fortunately, we had our role to play in the deal and it worked out for everybody.

[Sam Damiani, Analyst]

That's great. And is the relocation form the one in the north end of the city there?

[Kevin Salsberg, Senior Vice]

Yes, Sam, it's a reconfiguration of the market. It's essentially will be a consolidation of the 2 locations into 1 large one in the more central location.

[Sam Damiani, Analyst]

Got it. Very good. And just sort of big picture, what sort of tenants are you seeing sort of growing and looking at leasing space in your portfolio as you lease up some of the North Canadian Tire spaces in your developments in recent acquisitions? I know as you got a Farm Boy in the Lakeshore recently, which was great to see, but what are you seeing in -- over the Square and Fort St. John, et cetera?

[Kevin Salsberg, Senior Vice]

Sure. Farm Boy is a great example. They just opened at the end of January. And from what we hear, so far so good on that front. I think that the typical retailers that you've been hearing about are still quite active. The Winners, TJX Group, Dollarama, other dollar store operators, restaurants, pad tenants of that ilk. Fortunately for us, we don't have a ton of third-party leasing that we are undertaking. But in terms of the development opportunities we have that you noted, those would be the groups that would probably be most prominent.

[Operator]

As there are no further questions at this time, 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 first quarter results will be released in the second week of May. We look forward to speaking with you then.

[Operator]

Thank you, everyone. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.