Earnings Call: Q2 2021

Aug 12, 2021

Earnings release

Good morning. Welcome to the Automotive Property REIT 20 21 Second Quarter Financial Results Conference Call and Webcast. My name is Michelle, and I will be your conference operator today. At this time, all lines are in listen only mode. Following management's remarks, we will conduct a Michalak's question and answer session. Please be aware that certain information discussed today may be forward looking in nature. Such Forward looking information reflects The REIT's current views with respect to future events. Any such information is subject to Michelle. I'm pleased to report that the results are not reflected in the forward looking information. Mishaeli's Meanings under IFRS. Again, please refer to the REIT's latest MD and A for additional information regarding non IFRS Michelle Mejers. This call is being recorded on Thursday, August 12, 2021. I would now like to turn the conference over to Mr. Milton Laum. Please go ahead, Mr. Laum. Great. Thank you, Michelle. Good morning, everyone, and thank you for joining us. With me today on the call is Andrew Kallra, our Chief Financial Officer. While the automotive dealership industry, including our Tennant Group, continues to operate under COVID-nineteen related business restrictions, During Q2, automotive retail sales continued to rebound with significant year over year growth to date in 2021, Reflecting the resiliency of the industry. According to Desrosiers Automotive Consultants, new automotive Sales in Canada were up 33% for 6 months ending June 30 compared to the same period last year. This revamp demonstrates the success of the dealership operators in responding to COVID related business restrictions For both new and used vehicles. Our portfolio remains fully leased and we've had 100% contractual base rent collection under our We generated growth across all of our key performance measures in the quarter. In comparison to Q2 of last year, Our property rental revenue grew by 4.1%. Cash NOI increased by 8.6%. Same property cash NOI was up 1.1% and AFFO per unit diluted Increased to 22.1 percent sorry, $0.221 from $0.205 At quarter end, our debt to GB ratio was 41.3%, down from 43.2% at 2020 year end and 44.4 percent at the end of Q2 last year. We remain well positioned to deploy capital On growth opportunities. The capitalization rate applicable to our entire portfolio was 6.5% atquarterend, A reduction of approximately 10 basis points from Q1. The reduction of the capitalization rate in the quarter reflects a decrease Discount rates for our properties in the Greater Toronto and Montreal areas by approximately 20 basis points during the quarter, primarily due to industry wide single tenant retail and industrial capitalization reductions. This represents an increase of approximately 2% in IFRS value for our investment properties. As provincial COVID-nineteen related restrictions continue to ease, we anticipate the pent up consumer demand will continue to support Canadian new and used auto sales plus service work performed by our dealerships, providing greater certainty for dealership operators to shift from defensive strategies towards growth. While the pandemic has also impacted the vehicle's supply chain, resulting in constraints on specific parts, models and brands, We believe these supply constraints are temporary and will not have a material impact on our tenants. Further, these supply constraints are offset The strong performance of the industry and the strength of our portfolio Has resulted in continued favorable support from our lending partners. In Q2, we expanded and extended one of our credit facilities to a total of 5 years to 2026. I'd now like to turn it over to Andrew Kalra to review our financial results and positioned in more detail. Andrew? Thanks, Wilton. Good morning, everyone. Our property rental revenue for the quarter totaled $19,600,000 The 4.1% increase from Q2 2020 reflects growth from properties acquired subsequent to Q2 last year and contractual annual rent increases. Total cash NOI and same property cash NOI for the quarter totaled $16,000,000 15 Q2 a year ago. Growth in cash NOI was primarily attributable to acquisitions, contractual rent increases. Growth in same property cash NOI Primary reflects contractual rent increases. G and A expenses for the quarter were approximately 7.4% of cash NOI compared to 7% In Q2 last year, the higher G and A expense in Q2 this year was attributable to the REIT's growth to the divesting of the previously issued deferred units. Net income for the quarter was $17,900,000 Michelle. Fair value adjustments for the investment properties, which Milton just discussed, fair value adjustments to Class B LP Units and unit based compensation. FFO, AFFO for the quarter increased by 10.2% and 11.5%, respectively, compared to Q2 last year. Excuse me. FFO per unit diluted was $0.236 in the quarter compared to $0.222 in Q2 a year ago and AFFO per unit diluted increased 7.2 percent to $0.221 from $0.225 Michelle. This growth was primarily due to properties acquired subsequent to Q2 a year ago, Michelle, or $0.201 per quarter per unit in the quarter, representing an AFFO payout ratio of 91%. This compares to total distribution paid of $9,600,000 or $0.201 per unit in Q2 last year, Michelle, representing an AFFO payout ratio of 98%. The AFFO payout ratio was lower this quarter, primarily due to bad debt reversal related To the tenant receivables and contractual rent increases. The higher AFFO payout ratio in Q2 2020 last year also reflected the temporary diluted effect of the December 2019 equity offering. As at quarter end, we had a strong financial and liquidity position with approximately $8,200,000 cash on hand, dollars 75,000,000 of undrawn credit facilities, 7 unencumbered properties with an aggregate value of $101,400,000 providing us with additional financial flexibility and a debt to GBV ratio of 41.3%. Michel. We had $401,000,000 of outstanding debt at quarter end with an effective weighted average interest rate of 3.73%. We have a well balanced level of annual maturities and our weighted average interest rate swap and the mortgage term is 5.5 years. The weighted average return to maturity of debt increased to 3.3 years from 2.7 years in Q1 this year, Which was a result of the extension and increase of 1 of our credit facilities. I'd like to turn the call back to Milton for his closing remarks. Thank you very much. Great. Thanks, Andrew. We've continued to collect 100% of our rent in July In August of 2021, plus rent due under the deferral agreements, we've not received any additional deferral requests. With business restrictions easing on our tenants, in line with significant increase with back seat sedations for Canadians, The strength of our auto industry and economic conditions stabilizing, we feel confident that industry consolidation has started to accelerate and we should be presented with attractive opportunities for us to continue expanding our portfolio And drive growth in AFFO per unit. Given our strong balance sheet position, we can pursue acquisitions on a strategic basis Through debt financing and available liquidity. We believe we are also better positioned to access capital through the equity markets at this time. This concludes our remarks and we'd now like to open the lines for questions. Michelle, please go ahead. Michelle followed by the number 1 on your touch tone phone. You will hear 3 tone forms acknowledging your request and your questions will be pulled in the order Michelle received. Thank you, operator, and good morning, gentlemen. Good morning. Given that it's a pretty Obviously, you're doing what you can within the context. But just wondering, given the cap rate compression In the major urban markets you're looking at it, I'm thinking Toronto, Vancouver and Montreal. Are you having a hard time making deal economics work? And are dealership owners hanging on to properties until retirement when they can sell the whole package including potential rezoning for the real estate? A couple levels on that question. The first one is, yes, interest rates, Cap rates are very low right now. That doesn't tend to be what's getting in our way. We are starting to see and expecting to hear some deals Within the dealership community announced. So the activity we thought would start unfolding in the back half of twenty twenty one And into 2022, we're still confident that that is going to start to unfold. That's more when we get the opportunities as to buying As opposed to buying kind of existing marketing assets, a lot of the stuff we buy is off market associated with M and A. So certainly the Toronto, Montreal, Vancouver's, the cap rates across all industries seem to have gone down. And that's part of the reason why we reflected a bit of that in this quarter. And the second part with regards to retirement development, We've always said that if it's imminent development, dealers face a conundrum on do they sell their operations and real estate Or do they just collapse the dealership and then sell the asset for immediate redevelopment? We don't tend to play in the world where someone's going to collapse their dealership and develop it right away. That's going to go at a cap rate that is low, low, low Single digits kind of 1% or 2% holding income and then developed. And that's really not our business. We certainly like lands that have a higher and better use underlying, but they tend to be on mid to long term leases So dealers are always faced with the conundrum, do I sell the package and get value for operations and value for real estate? Or in certain locations, is the value of the real estate just too great and therefore they sell it specifically for higher density use. Thanks. That's helpful. Just kind of a follow-up on the sale of ongoing Businesses where they're not looking for rezoning opportunities. Do you see dealers having a Tough time making their own economics work just due to the higher rent payments that Would be needed to support lower cap rates? Well, I mean, the lower cap rates probably actually helps their Rental income, sorry, the rent overhead for obvious reasons. But yes, I mean the price for acreage in Toronto, Vancouver, Montreal is Not minimal. It's gone up and will continue to go up. So you're starting to see some locations that have Kind of the spoken model where you have retail that is a bit of a smaller footprint With the back, which is service, which obviously is where a lot of the dealers make their money and an additional service location that is In a secondary location, not on a major artery thoroughfare retail presence, that allows them to kind of reduce the real estate costs. And certainly, the use of off-site compounds is very prevalent in those three markets. And I would even say in the Calgary Real estate is just too valuable to just park cars on. It's better to have it at a secondary location And just valet it in when the order comes in. That's great. That's helpful, Milton. I'll turn it over. Thank you. Your next question comes from Mark Rothschild from Canaccord. Please go ahead, Mark. Thanks. Good morning, guys. Good morning. Maybe just following up a little bit on what you were talking about with the acquisition market. Are you getting outbid on any properties? And to what extent does the IFRS value you're using now and I You made a small adjustment, but nothing too significant reflect what's actually going on in the private market? Short answer is no. We're not getting out good. We've always had it that the lenders tend to be our biggest competition. And in some ways, we are looking at providing long term money because we're doing 10, 15, 20 year terms versus dealers looking at short term money with banks that are at low rates. So it's not that we're getting outbid. And certainly, we expect a bit more activity as we go forward. But It's always been we tend to get a last minute call saying come on in, let's do a deal quickly, as opposed to a long runway or A traditional industrial or retail marketed grabbing a CBRE colliers and saying we'll do a bid date in 6 weeks. That's not how dealers work and that allows us to be there on the last minute, but that also means there's not as much visibility of Okay, great. Thanks. Maybe just one more. So you're not getting outbid and clearly you have capacity to acquire a number of assets. You've been pretty disciplined in the markets that you're focused on. Is there any Discussion or interest in maybe expanding that, whether it's to smaller markets in Canada that you've kind of avoided or into maybe other Large markets in the U. S. Where you haven't really felt the need to go yet. We like metropolitan markets. And certainly there's some very strong metropolitan markets in the U. S. And there's other I don't even want to call them secondary markets, but The Kitchener Waterloo's, the Kelowna's, the Halifax's, the Sherbrooke's, the Winnipeg's, all of that We'd certainly look at for the right opportunity, right location and right operator. So we're not opposed to that. As much as we like Toronto, Montreal and Vancouver. That is a limited universe. We still think we can play, That's slightly lower cap rates and high quality real estate. We also think there's good quality real estate in other markets. Okay, great. Thanks. Your next question comes from Lee Chen, IA Capital Markets. Please go ahead, Lee. Hi, good morning, Milton and Andrew. Good day. I had a couple of questions regarding acquisitions, but you're answered. So I guess just a quick one for me. So just regarding the global chip shortage, I was wondering if you could provide more color on Dealership car sales. So as you mentioned, obviously, supply of new vehicles are obviously being scarce, but that's clearly being offset by increased demand for used Cars at a higher premium. So how do you think that's affected the profitability for the car dealerships over the last few months? Yes. If you look at the press releases from some of the auto retail groups out of the U. S. And even Canada, they seem to all start with record profits. So I'd certainly encourage you to Take a quick look at some of their press releases and that will give you a very good indication. But you already touched on it, which is The margins are up because in a weird way you can buy a 1 year old used car and pay more than a new car, because of lack of availability. So dealers are facing some supply chain issues, but that's allowing them to push pricing or maintain High levels of margins. So it's not all bad. I guess it's more important what's more important revenue lines or higher profit lines? And they certainly don't seem to be upset at higher profit lines. Okay, perfect. Thanks. I'll turn it back. Thank you. Just for fun, I'll stick with acquisitions here. Okay. It sounds like M and A chatter is picking up in the industry. How would you compare that to pre COVID level, say, about the same time in 2019? I would think in back half and in 2022 that will accelerate. The need for spend on technology, the need for spend on commerce, lower SG and A combined with Availability of capital and retained profits. Existing small dealer groups or dealers, single rooftop Dealers are certainly looking at am I going to reinvest or am I going to take my profits. And that's a pretty compelling Argument. So I think we're going to see some pretty good activities sorry activity in the M and A And I think it's going to be at a greater pace than it was in 2018, 2019. Okay. And are you this chatter, is it more single asset or are there some decent sized portfolios I think it's going to be both. I think there's going to be singles. And I certainly believe that there's going to be small, mid- and large sized dealer groups that may look at M and A activity. I think it's going to be both. Okay. And then just secondly On your distribution, like you guys obviously sailed through COVID fairly well in terms of 0, there's going to end up being 0 bad debt. Fundamentals are good. You've got a good balance sheet. What's keeping the Board from increasing the distribution? I think we'd like to do some more acquisitions and push AFFO up per unit before we do that. One of the things we've always said is that once we start doing a distribution increase, we would like to be able to do that on a regular basis. So it just starts becoming I don't want to say automatic, but a very regular increase. Our leases primarily I have embedded annual rent increases. So once we start doing that, we kind of want to continue to do it consistently. We have a philosophy that a one off Distribution increase, it's nice, but it's not as good as being a regular distribution increase. Short answer, we want to do some more acquisitions and drive AFFO per unit higher and then we'll certainly it's something that we think investors like and we like Overall as well is looking at increasing our distribution. Okay. Do you guys have a set The full payout ratio that you're trying to target? We in our strategy meetings and regular meetings, we look at Internal range on when we think that would be a good time to do it? Yes. We just haven't announced and we're not going to announce until we announce that we're going to do the distribution increase. Okay. So no announcement until the announcement? Exactly. Okay. Thanks. I'll turn it back. Your next question comes from Matt Logan from RBC. Go ahead, Matt. Thank you and good morning. Good. Andrew, in terms of the fair value gains this quarter, Can you talk a little bit about how much weight you place on single tenant versus industrial transactions in your market? And what drove the decline in cap rate this quarter? The drive was basically based on The market evidence and obviously we can't compare ourselves totally to industrial. We have to look at the overall market and also trades within the market And balance that out and the approach that we took is we've seen the GTA and the GMA And we looked at our portfolio and we also looked at previous acquisitions that we had completed in those areas as well And made adjustments in those specific areas given the fact that there was a difference overall. To that point, Matt, we kind of triangulate it because there's not a lot of Specific market evidence in Canada because we tend to be the dominant buyer of income producing automotive real estate. But if you look at single tenant retail, if you look at industrial, if you look south of the border, if you triangulate that, we felt very, very comfortable Certainly, our Montreal and Toronto area locations deserve the lower cap rate. Agreed. And based on what you've seen maybe in the market that hasn't closed yet, do you think there is potential For further cap rate compression over the next few quarters? It's going to be continually viewed every quarter and It's part of the process. I can't predict where we're going to be in Q3, but 6.5 is a very, very Supportable number at this point in time and we'll assess it as we go forward in Q3 and Q4. And maybe changing gears. We're starting to see pockets of strength in other areas as well. I mean Alberta is coming back. We certainly still like the Ottawa market. I mean there's we like what we're seeing out there. We just like to see more transactions. I appreciate the additional color. Maybe changing gears, Milton. With the U. S. Targeting 50% electric vehicle sales Whether it's a 50% target or otherwise, the short answer is The EV world is going to start unfolding. So that opportunity just is we think there's going to be Certainly, we like and have done transactions with Tesla. There's going to be more EVs coming to the market, both in brands and a push, Whether it's Volkswagen, Audi, BMW, a lot of the brands are going to start looking at more and more EV, which means some CapEx upfront. Anytime whether it's branding or CapEx for EV, anytime a dealer looks at the opportunity to expand and spend money. They're also going to look at is that a good opportunity to exit have someone else spend the money and take profits. So we think that's going to drive one of the factors that's going to drive further consolidation. We as that rolls over, that's Certainly new car sales, but there's also a lot of internal ICE, internal combustion engine vehicles that are going to be on the road for a long time afterwards and continue to be Very much on the sales side and service side. Appreciate the color. I'll turn the call back. Thank you. Thank you. Your next question comes from Himanshi Gupta from Hochobank. Thank you and good morning. So just on the cap rate discussion, how is the cap rates moving for U. S. Auto Dealership Properties. I mean, I'm assuming there's more activity there. There's more data available there as well. Yes. It's the U. S. There's more of everything there. We're seeing from what we've looked at As far as talking to some of our consultants, etcetera, down the States, they are seeing some cap rate compression. The industry overall is now viewed as More resilient than it would have been viewed pre COVID. Essential service, we've talked about we're collecting 100% rent. People are talking about dealership groups having very strong profits. All of that has just reduced any kind of risk factor that people are looking at and combination of reduced risk factor in a market that is showing lower yields means You're going to see lower yields on the and have seen lower yields on the asset sales in the States. Okay. That's helpful. And then just staying to your way of finding the cap rates or looking at the trends, it looks like you're looking at Single tenant retail and industrial properties in your calculation. Have you been looking at these single tenant industrial properties all I mean historically as well or it's only very recent that you are looking at the National Property Evaluation? We have to because of the lack of visibility on pure automotive properties. We certainly have to cast a bit broader net to see where the trend line is going across other industries And how that has an implication on our cap rates. So we've always looked at industrial and single tenant retail on a trend line as well. Okay, okay. Thanks. And then maybe you were talking about previously about the portfolio M and A Activity picking up. I mean, we read the news that a large U. S. Dealer, I think, Lithia Motors is trying to buy fast dealerships in Canada. So any read across or implications for your business? Yes. I can't Speak specifically on that one, but overall when you're seeing a large U. S. Group that has a very strong e commerce platform And availability of capital. One thing we've talked about and this is probably going back a couple of years ago, One of the limitations for Canada was you had some OEMs that wouldn't allow public ownership. Trades like The one you're talking about potentially can occur, that's just demonstrating that those constraints are no longer there. And The success they're having in the States, they are looking to export it and bring it to Canada. That will probably mean Groups in Canada are potentially looking at taking profits or looking at doubling down on their e commerce and their Platforms for omni channel sales. So I think it's a good thing. Anytime we stir it up just a little bit that keeps everyone on their toes. Good operators here and good operators from the States is not a bad thing at all. Yes. And maybe from my understanding, is You know, let's say you're buying the just the operating business or they're buying the rooftops as well from FAS? We don't have a answer to this on that. We got to wait to see what happens when it closes. Rumors and rumors and I can't really comment until everything's done. Got it. Okay. And maybe just last question for me. I mean, a lot of discussion obviously on the acquisition pipeline. Anything specific with Dilawri? I mean, do you know how much you can close with them by the end of the year? Any indications from them where they have been active on? No, I mean, it's not just Hilarie. It's all the dealership groups will call us I am late in the process, not early in the process. It's one of the reasons why we want to have and we do have The flexibility and the capability to react quickly is because we're often asked to act quickly. So Visibility discussions tend to be in general and then get very specific with a short fuse to it. Michelle. Your next question comes from Brad Sturges from Raymond James. Please go ahead, Brad. Brad, do we have you? Just wanted to maybe follow-up, you've talked a lot about valuation and more about cap rates and Maybe a little bit of replacement cost, but maybe if you could provide a little bit more granularity in terms of what you think replacement cost could be in some of your major markets, Charlotte Montreal and Vancouver specifically. Short answer is higher than it was a year ago. Yes. I mean, no surprise. Land values have gone up and construction costs have gone up. I haven't put an exact number on that, but you're certain to see Both time lines in getting the zoning is longer than it was previously. Costs, development fees, higher Materials higher, services, contractors higher and the underlying land value has gone up, Especially in the markets that you're talking about. So we haven't put a specific number on it, but yes, it's up. Right. And in terms of the development approval process, is it becoming really difficult just to get approval as you talked about in terms of it's not really the highest and best use to just put Cars on land. Yes. Planning offices don't have a love affair with Automotive Retail. We still look at it and we're proponents because if you look at it, it is High income, high number of jobs per square foot. It's not Minimum wage retail type stuff. It's they're making real money. So we view it very much as employment and some Planners are absolutely agreeing with that. But just whether it's automotive or any other type of developments In the major markets, that's a long timeline, complicated, and it doesn't seem to be getting shorter. Okay. But one of the things we've always said is we like the fact that we have zoning on the existing locations because it's Michelle? Hi. Sorry about that. We do have one more caller, Carl Bouley from National Bank. Please go ahead. Hey, good morning gentlemen. How are you? Good, Jeff. Good. Just maybe in terms of talking with your tenants, are you seeing any like variance among the brands or anything right now Just as we recover, I know you talked earlier about supply availability, like are there maybe certain brands that are maybe having a Others are doing better? Yes. I mean, anecdotally, we've heard about it in some of the Pickup Truck World, a lot of our brands tend to be more commuter, the Honda, BMW, Audi's of the world. Some of it's brand, some of it's specific models. So it does tend to ebb and flow. I will say that A lot of them have looked at refreshing their product line and that's creating some good excitement. And some of those are did it last year, some are doing it this year, some are doing it next year. So as they bring on new models that tends to drive a bit more excitement. But that's in our world, we're not really seeing it affect 1 In a negative way and the other one in a positive way tends to just be a bit of a rolling. And it's certainly why we like dealing with dealership groups. And As you know, a lot of our leases have indemnification from a group that has multiple brands in multiple locations. And that allows us to sleep at night. Got it. We talked a lot about M and A. I'm wondering if like as you look around the landscape, are there like other parts of sort of the automotive world that could provide other triple net opportunities to you. Like I think about here in this country, we've got service garage consolidators, Parts Distributors. Is that is there opportunities maybe outside of the pure dealership Type of Real Estate? I think there could be. And if you asked me if there's a beautiful Caterpillar location in Vaughan, would we like to own that? Absolutely. I think a lot of people would. So, I mean, I think there are some different ones that have a lot of the same characteristics in our automotive That we potentially could look at in the right opportunities. So I would say we view ourselves as automotive as opposed to just Automotive Dealership Retail. It's one of the reasons why we like dealing with Tesla because it's the direct OEM and they have a slightly different model. So as that whole industry continues to evolve, we think we're going to see other opportunities as well that may be not the specific dealership, but Are backed up with good covenants and strong real estate locations. And in the past, you've done some dealers Some development work. If we're thinking about how automotive retail might shift Over the next 10, 20 years of changes in the industry, does that seem like something you're probably going to be doing more of in the future? So you were talking earlier in the call about shifting inventory holding to land off-site that kind of stuff. Do you think there's going to be more I think It's inevitable and it's not pioneering. You go down to New York, you go over to Europe, you look in Asia, These OEMs are absolutely used to in high density locations being in a smaller retail footprint with an ancillary outside. That smaller dealership footprint may be and often is in a mixed use complex. There's a lot of moving parts to get there. And as long as you do it upfront as opposed to try to squeeze it in after the fact, it is doable and I think it's inevitable. Okay. And then just lastly, like when you guys went public, you sort of came out with a more novel Debt structure with multiple credit facilities and then layering the rate hedges in on top. As you guys have matured in the market, In your conversations with the banks, is there any opportunities to sort of Consolidate, simplify, look at maybe more cost potentially more cost effective Solutions on the debt side? I actually think in many ways what we have It's pretty simple. And in many cases, you're seeing some other REITs do it as well. If you've got an unencumbered portfolio, you can put together and get We're BAs plus 150. That's a pretty we think it's a cost effective use. A and B, we think it adds flexibility. So we certainly will look at specific properties in doing long term mortgages. We announced 1 last quarter. But short answer is we really like the fact that we Can take advantage of the credit facilities that have the flexibility and the cost of capital that it has. The next level would be unsecured And that's you've got to be a certain size to get there. And you don't want to do that too early because if it unwinds, that hurts a lot of things. Yes. Sorry, Andrew, were you going to say something there? It sounds like no. In terms of flexibility, I think over the last 5 to 6 years, We've renewed and extended our maturities on the credit facilities And had a healthy weighted average to maturity on the interest rate swaps. So I think it's the overall structure is working very well. And we've added a couple of mortgages in between as well. So, I think we've got a very, very good balanced approach to it. Okay. Yes, that's perfect. I was just curious if like over the time in the public and bankers maybe come to you with Different kinds of ideas around that, but that's great. Yes. Their ideas are always, can you roll everything together and let us be lead? I understand that strategy. We like to have different groups at the table, Because you don't want just pure herd mentality and you don't want to just be controlled by 1. All right. I got it. Thanks, Milton. Thanks, Andrew. Thank you. As there are no further questions at this time, I will now turn it back to Mr. Lam. That's great, everyone. Enjoy the rest of the summer, and we look forward to talking to you in Q3.