Earnings Call: Q2 2020

Aug 14, 2020

Earnings release

Good morning. Welcome to the Automotive Properties Limited Partnership 20 22nd Quarter Financial Results Conference Call and Webcast. My name is Joanna, and I will be your conference operator today. At this time, all lines are in a listen only mode. Following the management's remarks, we will conduct a 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 risks, uncertainties and assumptions that could cause results to differ materially from those projected in the forward looking information. For more information on the risks, uncertainties and assumptions relating forward looking information, please refer to the REIT's latest MD and A and Annual Information Form, which are available on SEDAR. Management may also refer to certain non IFRS financial measures. Although the REIT believes these measures provide useful supplemental information about financial performance, They are not recognized measures and do not have standardized meanings under IFRS. Again, please refer the REIT's latest MD and A for additional information This call is being recorded on Friday, August 14, 2020. I would now like to turn the conference over to Milton Lam. Please go ahead, Mr. Lam. That's great. Thank you, Joanna. Good morning, everyone, and thank you for joining us today. With me on the call is Andrew Kalra, our Chief Financial Officer. First of all, I'd like to apologize for being a bit later than we normally would like to on the results last night. We were waiting for a signature on the waiver on the subsequent events transaction that we announced. But glad to get it done and glad to get it out. Combination of our tenant base, consistent of leading automotive dealership operators in Canada and our strong liquidity position, enabled us to work with certain of our tenant partners to provide support during the partial rent deferrals as they manage the economic challenge imposed by the COVID-nineteen pandemic. As a result, we've collected approximately 78% of our base rents in Q2 2020, with the remaining amount subject to rent deferral agreements with tenants. This is reflected in our continued solid growth in revenue, NOI and AFFO for the quarter. In comparison to Q2 last year, our property rental revenue grew at 14.5%, cash NOI increased by 12.6% and AFFO was up 24%. AFFO per unit in the quarter was down from Q2 last year due to the closing of our December 2019 equity offering where we issued 7,900,000 REIT units and the partial deployment of proceeds from the offering. Our December equity raise deleveraged our balance sheet providing us with a strong liquidity position to manage through the onset of the COVID-nineteen pandemic. And as you know, provincial governments across Canada enacted emergency measures commencing in the second half of March twenty twenty to combat the spread of COVID-nineteen, including temporary closures or restrictions of non essential business. As a result of these measures, most of our tenants automotive dealership businesses were either closed or operating at a limited basis from the second half of March through to the second half of May. This has had a significant adverse impact on the automotive dealership business during this period, including a significant reduction in new car sales and servicing. As a result, automotive industry analysts have forecast Canadian new car sales will decline by approximately 30% in 2020 as compared to 2019. As of the end of May 2020, all of our tenants were fully open for business. Accordingly, Statistics Canada according to Statistics Canada, new automotive sales in Canada for the 5 months ending May 31, 2020 were down approximately 39.7% compared to the corresponding period in 2019. As provincial lockdowns eased in May, pent up consumer demand resulted in a rebound in Canadian auto sales and increase in service work performed at the automotive dealership level. According to one industry report, new automobile sales units in Canada for the month of June 2020 declined by approximately 16% as compared to June a year ago, a significant improvement from the preceding months. In Q3, this momentum continues estimated sales are approximately are down approximately 5% July over July last year. Many of our tenants have also benefited from the Canadian emergency wage subsidy program, providing them with further stability and a road to profitability. This and the improving sales and service levels have resulted in no new requests for rent deferrals from our tenants, and our tenants have started to pay back prior rent deferrals. We believe the ongoing recovery demonstrates the resilience of the automotive dealership industry and that automotive sorry and that automobiles are an essential part of our daily lives. We're also seeing the dealership industry's ability to adapt to the evolving consumer preferences and a more immediate consumer concerns regarding COVID-nineteen. With a robust online presence and e commerce options to facilitate consumer purchasing decisions with the availability of curbside pickup drop off combined with the essential service of vehicle maintenance. We're encouraged by these recent developments and believe the economic outlook for our tenants has significantly improved from this time in our Q1 discussion. I'd now like to turn it over to Andrew Kalra to review our financial results and position in more detail. Andrew? Thanks, Donnie, and good morning, everyone. Property rental revenue in the quarter was $18,800,000 an increase of 14 point 5% from Q2 last year, reflecting growth from properties acquired during and subsequent to Q2 last year and contractual annual rent increases. Total cash NOI and same property cash NOI, excluding bad debt expense for the quarter increased to $14,800,000 $13,200,000 respectively, reflecting increases of 12.6% and 1.2%, respectively, compared to Q2 a year ago. Growth in cash NOI was primarily attributable to acquisitions. Growth in same property cash NOI, primarily reflects contractual rent increases. G and A expenses for the quarter were approximately 7% of our cash NOI compared to 5.8% in Q2 last year. The increase primarily reflects expense associated internalization of management and operations of the REIT in line with our initial forecast. Net loss for the quarter was $23,400,000 compared to a net income of $8,400,000 in Q2 last year. The variance was primarily due to fair value adjustments for Class B LP units, DU and IDUs, investment property and interest rate swaps, primarily offset by an increase in NOI and lower interest expense and other financing charges. FFO for the quarter was $10,700,000 an increase of 21.8% compared to Q2 a year ago. AFFO for the quarter was $9,900,000 an increase of 24% compared to Q2 last year. Growth in FFO and AFFO was primarily due to properties acquired during and subsequent to Q2 a year ago and contractual rent increases. FFO per unit diluted was $0.222 in the quarter compared to $0.272 in Q2 last year. AFFO per unit was $0.205 compared to $0.24 in Q2 a year ago. Declines in FFO and AFFO per unit in the quarter were primarily attributable to the closing of our $92,000,000 equity offering December last year, resulting in the issuance of 7,900,000 REIT units, which deleveraged our balance sheet from a debt to GDV of 49.7 percent in Q2 last year to 44.4% at the end of Q2 this year. Total distributions declared and paid in the quarter were $90,600,000 representing an AFFO payout ratio of 90% to 98% compared to $6,400,000 in total distributions paid in Q2 a year ago, representing a payout ratio of 81.4%. We made a fair value adjustment to our property portfolio for the quarter, resulting in a decline of $10,900,000 mainly due to a 10 basis point adjustment made to valuation inputs, reflecting the impact of COVID-nineteen on all our tenants. The overall capitalization rate applicable to our portfolio property portfolio increased by 30 basis points to 6 0.9% as at June 30 compared to 6.6% as at 2019 year end. The cap rate applicable to our portfolio at the end of Q1 this year was 6.8% following the fair value adjustment $23,100,000 in that quarter, again related to the impacts of COVID. I'll conclude with a review of capital resources. Our liquidity position at quarter end included approximately $75,000,000 of undrawn revolving credit facilities and $3,800,000 in cash. Further, we have 8 properties valued at approximately 128,000,000 dollars that remain unencumbered, providing us with additional financial flexibility. While we do not expect to exceed the original limits contained in our credit facilities, we continue to enjoy strong support from our lenders and proactively engaged in discussions regarding the modification of certain financial covenants related contained in our credit facilities. As a result, 2 of our lenders have amended their respective credit facilities to remove the cap on the REIT distribution at 100% of AFFO payout ratio calculated on a rolling 4 quarter basis as long as our debt to GED is less than 55%, well above our current debt to GED of 44.4%. The 3rd lender has increased the rolling cap on AFFO payout ratio to 110% until September 30 next year, 2021. We had $389,000,000 outstanding on our credit facilities at quarter end with an effective average interest rate on debt of 3.77%. We have a well balanced level of annual maturities and our weighted average interest rate swap term is 5.5 years. I'd like to turn the call back to Milton for closing remarks. Thank you. Great. Thank you, Hunter. While our acquisition momentum has been muted by the impacts of the pandemic, we expect to see increased opportunities in future quarters as the industry fundamentals stabilize and the dealer consolidation accelerates. Yesterday, we waived conditions for the purchase of the automotive real estate in Laval, Quebec. We have secured a long term commitment from a luxury high end automotive company that will occupy the premises. We estimate that the total expenditures related to the purchase, including sorry, to the price and certain improvements costs related to the expenses will be approximately $13,400,000 We continue to benefit from strong relationships with some of Canada's largest automotive dealership groups and continue and conditions improve excuse me, as conditions improve, we believe our current tenant group will be the leaders in the future consolidation of Canada's automotive dealership business. And we should present continued opportunities for the REIT to strengthen our dealership partnership and build on our portfolio through accretive acquisition with our tenants. In evaluating potential opportunities, we'll maintain strategic acquisition criteria, focusing on select markets, property location, automotive brand and the financial strength of the dealership business operator. This concludes our remarks, and I'd now like to open it up for questions. Joanna, please go ahead. Thank And the first question comes from Jonathan Kelcher at TD Securities. Please go ahead. Thanks. Good morning. Good morning, Jonathan. First question just on the Laval deal. What's the existing dealership that's there now? There is no existing dealership. It is a automotive property that we are going to be doing certain improvements and we're going to be we simultaneously are doing due diligence put under put it under a long term lease. Okay. And okay, let's see what is the purchase price versus the redevelopment cost to get to that $13,400,000 The vast majority of that without purchase price. It is not a significant redevelopment. It is more improvements that we have to do to get it up to modern standards to allow the tenant to do their work to modern standards to allow the tenant to do their work and move in. We do not expect this to be a long term sorry, we do expect that this to turn around and become income producing sooner than later. Okay. Is this an existing dealership group that you guys have a relationship with? I can't get into too much details because we are under a confidentiality agreement. And we'd certainly like to have them well, we're obligated to allow them to do their grand opening announcement. I'm just talking about the like is this a new tenant for you guys or is it an existing tenant expanding? This opportunity was brought to us by an existing tenant to work with them to allow this transaction to come together to acquire the property and get it ready for them on a long term lease basis. Okay. And then just switching gears, the $400,000 reserve that you guys took, I'm assuming that's just you guys being conservative here? Yes, Jonathan. It's just being prudent and conservative. We expect full collection that we wanted to provide for it in the quarter. And as that AR balance as we're collecting in July August, we'll see that AR balance drop and then obviously provision will drop correspondingly. Okay. So you'd probably reverse it over the next couple of quarters assuming all the money comes in? Yes. Both kind of decline naturally? Sorry, Andrew, go ahead. Yes. No, it's exactly the one thing. The A bonds can decline naturally based on the full agreements and we'll see that, exactly what you said, Jonathan, over the next few quarters. Okay. And then just on that, I guess, the 99% rent collection number seems like a little bit of a funny number to me. What hasn't come in? So I'll flip it the other way. What has come in is all of our July August rents. The difference was obviously some deferral and just getting back up to speed on that. But as mentioned, our tenants have started paying back on the deferral agreements. Okay. So 100% of July August rents have come in and then you're a little bit on the deferrals? Correct. Okay. Thanks. I'll turn it back. Thank you. The next question comes from Tal Woolley at National Bank. Please go ahead. Hi, good morning. Good morning. Good morning. Just in your conversations with the dealerships right now in terms of their operations, like are there any big hitches for them in terms of being able to restart their business, like any big challenges getting inventory, staffing service base, that kind of thing? No. On the service side, that was a specific question I've asked recently, is kind of parts inventory. The service side has that is certainly an area of pent up demand and that's rebounded nicely. Dealership groups that I'm talking to are pleasantly surprised at the speed of the recovery. The inventory on the new car dealerships is interesting because if you ask the OEMs, they're a bit grumpy about it. But if you ask the dealers a bit more sales. If there's only so many cars out there, you can demand to get closer to your manufactured price. You will see how quickly the OEM incentives have declined from April, May, June, July, and that is a big indicator. So it for the profitability of the dealership businesses, lower inventory is probably a good thing. Okay. And then just on your on your or go ahead. The rest of it on the hitches, the only thing we're really hearing is, again, a double edged sword. Certainly, the wage subsidies that the government's offering is assisting them. But at the same time, some of their employees are more than happy to stay at home. So as they're ramping back up, getting the staffing back in, certainly expected, but the wage Okay Okay. And then just on the balance sheet, your debt stack is unique that you rely extensively on bank debt. It sounds like conversations with your lenders have been fine and there's no real shift in credit availability there. Have you guys given much thought to maybe diversifying that stack a little bit? Like maybe you'd go and try to get mortgages or use more secured debt? Just wondering, obviously, things can change quickly in this market. And so just wondering your thoughts about trying to diversify capital structure. Sure. We've talked about it a number of times. What you're asking us to do is take a step back as opposed to a step forward. Kind of in the evolution, I kind of look at it as we look at it as mortgages. And then once you get enough unencumbered assets, you'll do pools that have the flexibility that our credit facilities do. And then if you get to a multi $1,000,000,000 state that you can get rated, you will go and do some unsecured. So we're certainly not at the latter, but I also don't believe we're at the former. The world of increasing properties, mezz debt is incredibly expensive. The amount that we've had to that when I was in my last life in the brokerage had to deal with on defeasements It's very tough to sometimes handle. This structure has worked extremely well for flexibility. And when you see our relationship is fine, as Andrew mentioned, we proactively knocked on their door and they were very good as far as we understand you're only 44.4%. This is what not was originally intended. We shall amend or modify. So no, we continue to enjoy support. That doesn't mean on specific properties, we won't put mortgages on when the opportunity is right. But at this point, we have $128,000,000 of unencumbered assets as well. Okay. Just to reiterate that, Paul, I mean, we've talked about the flexibility of these credit facilities. We've renewed and extended all 3 of them over the last 5 years. So they worked out very well for us. Okay. And then just lastly, what do you think the pandemic sort of done to your view on the prospects or how has it changed your view on the prospects for consolidation and acquisition pricing that we're sort of hopefully through the initial first and hopefully worst part of it? Yes. And I certainly believe we are. 2 things that I think the pandemic has done. First one is people are valuing their personal space more. And that is both probably in less use of public transit, but also whether it's improving your house because you're spending more time there or people it's interesting luxury car sales are doing well because people want to be in a space that they enjoy right now. So that's an interesting hallmark of as we evolve personally that people do like to have their own bubble, their own space. When it comes to M and A, as you can imagine, the banks were very good to most businesses, including dealerships during the COVID period. And now everyone's taking a step back and saying, this has broken, what are we going to do next? By broken, I mean, the COVID emergency shutdown has stopped. What's our next step? And that's both and so I'm sure some people are looking at exits and other people are looking at ramping up. I expect to see more of that as it digests and people think about it. And quite frankly, there's going to be a buy sell gap that occurs at the beginning. And then as people get more serious, the pricing will come together. So I expect to see a lot more activity we finish off 2020 and certainly going into 2021. It also leans towards the requirement to have a very strong e commerce platform, and that just naturally gives an advantage to some of the larger dealership groups. Okay. That's great. Thanks very much, gentlemen. Thank you. The next question comes from Matt Logan at RBC Capital Markets. Please go ahead. Thank you and good morning. Hey, Matt. Good morning. Andrew, just wondering if you could walk us through some of your valuation inputs. In terms of your higher discount rate, were there any specific properties or regions or is it just more of an across the board change? Sure. In Q1, we did focus obviously on COVID-nineteen, but as well as Alberta. And that was a portion of the increase in Q1 that related to Alberta. In Q2, the 10 basis points was pretty much across the board on the overall portfolio. And that was specifically just to take into account the impact the COVID-nineteen on our tenants. I believe we've done a very good job in taking proactive on Q1 and Q2 on our property valuations. And we're in a good position for 2020. We'll assess things as they go, but that's the mindset that we've used. Yes. 6.9%. I would argue that's partly because as you were to market a property right now that has a deferral just off of the COVID shutdown, that naturally the psychology of an investor is not as positive as when you're kind of back into normalized rent and that that COVID memory is 6 months, 9 months, 12 months old. So I think that's just a practicality of when you're driving volume, you see we were beaten up as a lot of people were in March April. And that's because you drive by a dealership and you see it's got it's closed for the moment that doesn't make you feel good as an investor. But having it back up, back current and going, we certainly think that 6.9%, we are being very prudent and we will see where that goes in the future, but we don't expect that to continue to increase our cap rate. But suffice it to say as the recovery takes hold, the bad debt in collections progress positively, we could start to see valuation normalize in 2021 if things improve? Well, I mean, we've always said we liked our tenant base. And COVID happened, the Q2 happened and it's showing the resilience going to Q3 and going forward. So looking at a rearview mirror, I think this will kind of have a positive view as opposed to a negative that it was in the very moment that it occurred. And in the positive view, would that be more principally on the acquisition opportunity? Like do you see more portfolios for sale or assets that you might not otherwise be able to acquire? That's what we're quite frankly hoping. It's a double edged sword of how quickly the recovery has occurred. The great news is it's occurred and it could how much of it is just pent up demand, how much of it it carries forward, that's the question mark. People will do some thinking about what they want to do with their businesses that should provide opportunity. I do think that our biggest competitor has always been banks providing very high LTV mortgages to dealer operators. So as we go forward, I think they'll be a bit more conservative on that and that will help us. We've always said and we've actually been able to take advantage when there's a large portfolio sale to be able to be at the table. So we hope and think that will occur again. I just think there will be a small lag before that momentum really kicks in, but we are hoping and expecting that momentum. So I guess if we roll that up, there's interest, there's a lot of discussions, but there's still a bit of a bid ask spread in the market? There's a bid ask spread and similar to ourselves, it is a great we've got through it. We're enjoying a very good pace all right now at this very moment or do we want to see how things unfold a bit and make sure we are actually going at the opportunities that are the best opportunities that are coming forward. I think that's the same thought process that's going through a lot of the dealership groups that I'm talking to. They're having discussions with us to make sure that are we ready to react, are we there for them as opposed to specifics, this is the deal. That's great color. That's all from me. I will turn it back. Thank you. Thank you. The next question comes from Troy MacLean at BMO Capital Markets. Please go ahead. Good morning. Just on the 2021 lease renewal, have you started talking to the tenant and has COVID impacted what you think the market rent will be for that property? Interesting question on the second one. The first one is, yes, we disclosed that we are under discussions with them. It is a high quality dealer brand, high quality dealer, high quality brand, great location. We are not surprised that there are discussions going on. Dealerships groups are not opposed to using whatever is in their environment around them to ask for a better deal. But it is a very high quality piece of real estate, and we certainly want to get commensurate rates to what's out in the marketplace. It's interesting there has been a bit of a void on recent transactions as you can imagine, but that void is only 3 to 6 months. So, hard to say exactly where we'll end up, but I'm feeling more positive than negative. And then on the acquisition in Laval, was that something that started before the pandemic or was that post pandemic? Interesting question. It was for us, it was during the pandemic that it was brought to us. The group that brought it to us had been looking for a location and I think it engaged and kind of factored in on this before COVID, but brought it to us in COVID to help become part of the solution. And then would it be fair to say, considering that the redevelopment is quite light and it's pre leased that the overall yield is going to be close to what a regular acquisition cap rate would be for that market? We did an acquisition of a property and we did a lease and we've got to do some work. I still believe in the adage get paid for your work. So it's not dramatic, but I would hope putting all the pieces together, you get paid a bit more for doing that effort. And then do you think I know you've done a couple of these now, redevelop a property, I am thinking of the one on Kitchener. Is there much more room? I know it's probably you can't predict these things, but do you think you'll see more of these in the future like this type of deal? Going back to the comment I made with Matt, I think the banks are not as flexible as they once were. So that probably provides us with a bit more opportunity. And that we don't mind the idea of some redevelopment, especially in this case, it's minor redevelopment. And we don't even mind the idea of doing some developments, prefer to get through a bit more of this of our current 2020. But as long as we have we don't like spec. So as long as we have a long term lease commitment, we'll certainly work with the dealership groups to be able to provide a solution. So I'd like to see and think we will see more of that again going on in the future. I don't know for the next little bit. One thing I can say is OEMs have pulled back a bit on their demands of dealers for image improvements and new builds. So as you can imagine, everyone's just kind of put their head down a bit. Now when that pops back up is another question. So I think it would be more in the redevelopment world and more in the sale leaseback than brand new builds. Thank you for your commentary. I'll turn it back now. Thank you. There are no further questions. You may proceed. That's great. Thank you, everyone. Enjoy the rest of August. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines. Enjoy the rest of your day.