Earnings Call: Q1 2020

May 15, 2020

Earnings release

Good morning. Welcome to the Automotive Property Suite 20 21st Quarter 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 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 actual results to differ materially from those projected in the forward looking information. For more information on the risks, uncertainties and assumptions relating to 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 that 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 to The REIT's latest MD and A for additional information regarding non IFRS financial measures. This call is being recorded on Friday, May 15, 2020. I would now like to turn the conference over to Milton Lam. Please go ahead, Mr. Lam. 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. Our expanding portfolio of properties on triple net leases with contractual rent increases continues to drive significant growth. In comparison to Q1 last year, our property rental revenue grew at 18.6%, cash NOI increased by 17.9% and AFFO was up 28.5%. And AFFO per unit in the quarter was down slightly from Q1 last year due to closing of our December 2019 equity offering where we issued 7,900,000 REIT units and the partial deployment of the proceeds from the offering. This December equity raise has delevered our balance sheets from a debt of GBV of 56.3% in Q1 a year ago to 44.9% at the end of Q1 2020, providing us with a strong liquidity position to manage through this period. We deployed some of the proceeds from the December equity offering in early February as we closed 2 dealership acquisitions for an aggregate purchase price of approximately $29,000,000 including Regina BMW and Northshore Acura properties in Vancouver and Regina, both of which were Dilawri properties. The outbreak has had a significant near term impact on the automotive dealership business, including a reduction in new car sales and services. The automotive industry analysts have forecasted the Canadian new car sales will decline by approximately 30% in 2020 compared to 2019 as a result of the COVID-nineteen closures, although there can be no assurances given in that regard. Provincial governments across Canada enacted emergency measures commencing the second half of March twenty twenty to combat the spread of COVID-nineteen, including temporary closures or restrictions of non essential businesses. As a result of these measures, a number of our tenants' automotive dealership businesses were closed or operating on a limited basis and will remain so until further notice. Further, heightened health concerns and economics uncertainty have resulted in delayed consumer automotive purchasing and servicing decisions, which has impacted the automotive dealership operators that have been permitted to remain open or partially open, in line with their perspective sorry, respective provincial government guidelines. While dealerships in the provinces of BC and Alberta have been permitted to remain open, In Ontario, dealerships were open only to varying degrees and on a limited basis, including full closures. The Ontario dealerships are now open by appointment only and next week will be fully open yet again. Our dealership tenants in the Greater Montreal area have been closed except for service and repair for essential services, whereas the rest of the province's dealerships just recently opened. Since late March, we've been in communication with our tenant partners regarding the financial impact of COVID-nineteen has had and are continuing to have on the respective businesses. We are proactive in working with our tenants to help them work through this difficult period And our solid financial liquidity position enable us to provide needed support to certain of our tenants through limited rent deferrals for a 3 month period commencing in April or May, with no expected impact to the REIT's distribution policy. As a result of these tenant deferral agreements, we've either collected base rents or entered in a rental deferral agreements representing an aggregate of approximately 94% of the REIT's base rent in April May 2020 with all deferred amounts payable by July 2021. Specifically, the REIT has collected base rent from tenants representing approximately 75% of its aggregate monthly base rents in April May. We are continuing our efforts to enter into the rent deferral agreement with 1 tenant group remaining representing the remaining 6% of the REIT's current monthly base rent decisions. I'd now like to turn it over to Andrew Kalra to review our financial results and position in more detail. Andrew? Thanks, Dalton, and good morning, everyone. Property rental revenue in the quarter was $18,600,000 an increase of 18.6% from Q1 last year, reflecting growth from properties acquired during and subsequent to Q1 last year and contractual annual rent increases across a significant portion of our portfolio, total and same property cash NOI for the quarter increased to $15,800,000 $12,700,000 respectively, reflecting increases of 16.4% and 1.1% compared to Q1 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 6.5% of our cash NOI compared to 5.7% in Q1 last year. The increase primarily reflects expenses associated with the internalization of management and operations of the REIT in line with our initial forecast. Net income for the quarter was $15,700,000 compared to a net loss of $17,900,000 in Q1 last year. The variance was primarily due to fair value adjustments for Class B LP units, DUs and IDUs, increased NOI offset with increased NOI and lower interest expense and other financing charges, partially offset by fair value adjustments for investment properties and interest rate swaps. FFO for the quarter increased to $10,800,000 or $0.224 per unit diluted compared to $8,600,000 or $0.269 per unit in Q1 last year. AFFO increased to $9,800,000 or $0.28 per unit diluted compared to $7,800,000 or $0.243 per unit in Q1 last year. The declines in FFO and AFFO per unit in the quarter were primarily attributable to the closing of our $92,000,000 equity offering in December 2019, resulting in the issuance of 7,900,000 REIT units, which deleveraged our balance sheet from a debt to GBV of 56.3 percent in Q1 last year to 44.9% at the end of Q1 this year and the partial deployment of proceeds from the equity offering on the acquisitions of additional cash generated generating dealership properties. Total distribution paid in the quarter increased by 50.1% to $6,000,000 to $9,600,000 representing an AFFO payout ratio of 96.6 percent compared to $6,400,000 in total distributions paid in Q1 a year ago, representing a payout ratio of 82.7%. While we have never previously adjusted our cap rate, maintaining it at approximately 6.6%, we made a fair value adjustment to our property portfolio for the 3 months ended March 31, 2020, resulting in a decrease of $23,100,000 mainly due to adjustments made to valuation inputs, reflecting the impact of COVID-nineteen on all tenants and the impact of depressed commodity prices in Alberta, the overall capitalization rate applicable to our entire portfolio increased to 6.8% as at March 31, 2020 compared to 6.6% as at December 31, 2019. I'll conclude with a review of our liquidity and capital resources. Our liquidity position as at March 31, 2020 included approximately $64,000,000 of undrawn revolving credit facilities and approximately $20,000,000 in cash. Further, we have 8 properties valued at approximately $129,000,000 that remain unencumbered, providing us with additional financial flexibility. Cash requirements in the next 2 years are low and capital expenditure requirements are expected to be insignificant. We had $404,000,000 outstanding on our credit facilities at quarter end with an effective weighted average interest rate on debt of 3.77%. We have a well balanced level of annual maturities and our weighted average interest rate swap is at 5.7 years. I'll turn the call back to Milton for his closing remarks. Thank you. That's great. Thanks, Andrew. Through 2019, in the Q1 of 2020, we made strong progress in expanding our portfolio through acquisitions with the addition of 9 dealership properties. Through these acquisitions, we further diversified our tenant base and geographic presence in metropolitan markets across Canada. While our acquisition momentum has been stalled due to COVID-nineteen, we expect to see increased acquisition opportunities in the quarters ahead. When the time comes, we'll maintain our strategic focus on select markets, property location, financial strength of the dealership business operator and the automotive brand. While new vehicle sales in Canada were down slightly in 2019 compared to 2018, the overall business was very healthy. The period between 2016 2019 represented the 4 highest years on record for new vehicle sales in Canada. 2020 was off to a positive start until mid March. It is important to remember that automobiles are an essential part of our daily lives and delays in vehicle service or purchases should provide a healthy recovery for our tenants as the restrictive measures are lifted and the outbreak is contained. Our current focus is prudent managing the REIT's available resources and we have proactively raised our level of planning to adapt to the current environment. Our focus on capital preservation and liquidity has pushed our AFFO payout ratio to 96% 92% over the trailing last 4 quarters, as we have proactively deleveraged to a debt to GBV of 44.9 percent and have $85,000,000 of liquidity through cash and credit lines available. We have continued to have strong relationships with their senior lenders and approximately $129,000,000 unencumbered properties. We continue to benefit from our strong relationships with some of Canada's largest automotive dealership groups. As conditions improve, we believe the current Tennant Group will be the leaders in the future consolidation of Canada's automotive dealership businesses, which should present continued opportunities for the REIT to strengthen our tenant partnerships and build our portfolio. Our properties are located in attractive commercial corridors of Canadian's urban markets, mostly Fectum. We're confident in the intrinsic value of our portfolio and our opportunity for long term value creation. That concludes our remarks and I'd now like to open the line for questions. Joanna, please go ahead. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Your first question comes from Jonathan Kelcher from TD Securities. Please go ahead. Thanks. Good morning. Good morning, Jonathan. Good morning. First question, just on the deferral deals that you guys have completed, were they basically all the same deal? They were very similar. We did come out with a standard proactive and then kind of tailored it to some had already paid their March sorry, their April rent as an example, and some of them requested different payback periods. But essentially, our mantra, our thought process going into this was we have long term tenants, an average of 13 years. So this is a long term relationship. We took a step back and said this business is going to be important once this COVID epidemic subsides. So we want to work with them and partner, but to me that means partner. It's not a 100% on deferral and it's certainly we certainly understand that their business has changed for that short period of time. So it was rolling a sleuth up to do something together. But so I would say that the deals are not too dissimilar, but they're not exactly the same. Okay. And then just on the one tenant that you're still waiting to do a deal with, what happens if we're a couple of months down and they're still not paying? What would the process be on that in terms of, I guess, dealing with the OEMs or locking them out? How would that work? We've focused on the larger groups. So it's multiple brands, multiple locations with indemnification for the most part of the top, including this group. It's I certainly hope and don't believe it will get to that point. But if it is, we certainly these locations are very valuable for the OEMs. So no one wants to lose open points, especially as they've lost essentially a quarter worth of sales due to COVID and everyone wants to ramp back up in Q3 and Q4. So we've said before that one of the things we like about this business is we do have I always said it's kind of a shadow covenant with the OEM and that these franchises are worth even in today's world, it's been a bad quarter, but high quality franchises are still going to be in demand going forward. So I like the backstop of that. It doesn't help month by month, but it certainly helps overall on the long term leases. Okay. I will turn it back. Thanks. Thank you. The next question comes from Kyle Stanley from Desjardins. Please go ahead. Thanks. Good morning, guys. Good morning, Co. Good morning. I guess just kind of following on to John's questions there. Are you aware of the OEMs providing any financial or other assistance to dealer networks at this point? We're not in the day to day business, but certainly we're in communication both with our tenants and with other dealership groups. And my understanding is a lot of vendors to the dealership groups, certainly the OEMs, certainly the banks, a lot of groups have stepped in to provide support. The OEMs, I mean, it's going to be support and flexibility both with the dealers, but also with putting out programs to get the consumers back in the showrooms. You're certainly seeing that on the ads on TV. They're going to be very proactive on that. So it's a combination of both and some of their revenues are going to be on sales targets etcetera. And my understanding is the OEMs continue to work with them to allow them to it's an incredibly important part for OEMs to have this distribution model in place. So they're doing what they should and need to do to keep dealers happy. Okay. Thanks for that. And my next question is probably for Andrew. Just from an accounting perspective, how do you plan to treat the deferred rent from your tenants going forward? So the deferred rent is being recorded as revenue and we'll have a receivable on our balance sheet and we'll have an allowance if required of a percentage for allowance for doubtful. But the revenue will be recorded. So the impact on AFFO net income, it would only be the allowance. And at this point, we have not put an allowance in place, right, Andrew? Yes. That would be an issue that we have to deal with in Q2. But Q1, obviously, we were 100% collected. So that was not a concern for Q1. Okay, great. And then just my last one here. With your balance sheet in good shape at this point, can you talk about what opportunities you think could emerge on the other side of COVID? It's a higher level question and obviously we're still very early on, but just what you think could happen longer term? Yes. It's not fully a higher level question because it's something we kind of look forward to. No one likes where we're at right now. But one thing that we'll do is accelerate the consolidation that everyone was seeing to a certain level and certainly anticipating to see more of. This is going to drive the have and the have nots And individuals who are considering retiring may decide this is a very good time to do that. I don't think that's in the next kind of months, but certainly it's in the next quarters. And we'd like to see the business back on track and more visibility from our standpoint before we walk away from some of the strong liquidity that we have to drive the purchases. But we see this as a midterm, kind of short to midterm is going to provide some good opportunities out there. Okay, great. That's it for me. I'll turn it back. Thanks. Thank you. The next question comes from Brad Sturges from IA Securities. Please go ahead. Hi, good morning. Good morning, Brett. I guess starting with your comments about certain locations being closed or partially open, just what's the percentage of the portfolio that would have been fully closed? And what's from your point of view, what's the timeline of getting back to kind of a full reopened dealership? The one on the last part of that question, the one remaining question is Montreal. So they got postponed another week, I think yesterday. Everyone's expecting that maybe to get pushed 1 more week. So let's look at potentially in early June. Once that occurs, everything else will be open. They announced yesterday that it's going to be not just by appointment, it's going to be fully open for the Ontario ones next week. So really outside of Montreal after the long weekend, everything will be back open. And then when it comes down to who is closed when, some dealerships were proactive on closing and some did it based on municipal or provincial regulations. So we never got a full snapshot on the exact percentage at any time, but our understanding is there were not a lot of closures in BC. There were very few closures in Alberta. And certainly, there were up to well, not up to there were 100% closures in Quebec and Ontario. Okay. And then just to go back to the questions around the remaining tenants that you're negotiating with, Can you give a sense of when you think you could get an agreement in place? And I guess you're going to follow that template you've been using? That's we made proactive offers on a very similar basis to essentially all of our tenants. So yes, this is short answer. I can't answer because it's a two way street. My preference would have been to have had it done April 1, but sometimes it takes a while and everyone's got different things that they have as priorities. Okay. And then maybe just lastly, in your final comments there before opening up to questions, you're talking about the potential for acquisitions. Yes. In the future, when you look at the existing dealership groups that are tenants today, would they already own some real estate that would be of interest to the REITs and maybe there's a sale leaseback opportunity within that pocket at the moment? We like our liquidity. So certainly if there is an opportunity that would not normally be there in normal times, That might be intriguing. But I think right now, everyone's we want to see a bit more visibility. We've done we continue to monitor and look at let's take a step back. We like our liquidity position. We got that liquidity position because we did a raise to continue our momentum on the acquisition side. It's ended up being a very nice security blanket to allow us the flexibility and comfort. That is a beautiful thing right now. And then once there's more visibility going forward, it's going to be back to what we originally intended it for, which is to kind of grow the business, grow the AFFO and grow the AFFO per unit. It's just what is the moment in time and what are the opportunities. And quite frankly, normally when I've seen this type of scenario, you're going to see a bit of a buy sell gap, where the vendor is going to talk about pre COVID numbers and I'm going to talk about post COVID numbers. So that takes a bit of time to kind of settle down as well. I guess I was thinking more in terms of maybe the tenants that are looking to shore up their own liquidity positions, maybe looking ways to monetize assets that they do have? I'm finding everyone's no one's doing real knee jerk reactions. Everyone's being pretty thoughtful. So I'm not saying that that won't happen. But again, we like our liquidity position and there is going to be a buy sell gap in the initial stages. So we're not going to stretch on pricing just to buy something today when we value our liquidity. It has to be something very compelling. So I wouldn't say no, but I wouldn't say that that is something that we expect to see immediately. Yes, great. Okay, I'll turn it back. Thank you. Thank you. The next question comes from Troy MacLean from BMO Capital Markets. Please go ahead. Good morning. I'm curious, what's happening right now change how you want to underwrite a property like in terms of like rent coverage or tenant strength or what are your thoughts there? My thought is rent coverage got blown out the window because no one expected a quarter where there was very little activity. This is not your traditional business model. What it has done is reinforced our thought on working with major markets, making sure the underlying real estate is very high quality, making sure it's got a brand on top that's good, making sure there's indemnification from a group beyond just the one single location. So some of the tick boxes that we looked for before we proceeded with acquisitions, we look back on and we're like, okay, good, glad we put that in place. Certainly, I do believe that one thing you're hearing about the changes on this model, remember we have 13 year leases, but is that there is going to be a lot more of a push for potentially smaller showrooms, continued significant service area and more e commerce and more technology. Crisis, what's that comment from the godfather, no one wants to waste a crisis. So that's going to be a bit of a change, but I think that's just accelerating the evolution that was already occurring and we already had kind of in our thought process. What about your geographic mix? Alberta looked like it had a bigger increase in the discount rate applied to it. When you look out over the next 3 to 5 years, do you expect to bring down your weighting to Alberta? I mean, I guess the short answer is yes. I don't know if it's 3 to 5, but certainly in the next 1 to 3, they tend to have a tendency to bounce both down and up. But I think in the near term, Alberta has been hit with a double whammy. And that's why we were more proactive on increasing the cap rates for the Alberta region than anywhere else, because it's not just COVID, it's also the underlying economy. So I think naturally as we do acquisitions, you'll see that percentage go down a bit. And then just finally, on your unencumbered property pool, can you give us any kind of guidance of where they're located? Sure. I mean, it tends to be the more recent acquisitions. And that is because we've had a tendency intentionally so through planning that we normally finance our previous acquisitions as opposed to doing a hurry up and offense and trying to finance our existing our current acquisitions. So it always has a bit of a lag and that allows us the ability to kind of put it in place and pull the trigger quickly. So as a result, it's our more recent acquisitions that would be included in that, and that's everything from Regina BMW to the Acura out in Vancouver to the Queensway Audi to some of the AutoCanada purchases that we've done. You can take a look at our track record and our cadence and you can figure out which properties they are. Thank you. That's good color. I'll turn it back. Thank you. The next question comes from Sumayya Saiy from CIBC. Please go ahead. Thanks. Good morning. Good morning. Good morning. Good morning. So just on the deferrals, you've given granted a fair bit. And as you sit through and reviewed the request, what are you looking for to gauge dealer health and what timeframe have you considered so far? All the deferrals are to start being paid back and be done by July of 2021. So they're all within essentially 12 months from the end of the deferrals. So we're comfortable with that. On the dealer health side, I mean, it is we do not get financials except for the Dilawri ones that are provided in the MD and A. So it is really watching what is happening in industry through various industry reports and direct discussions with dealer with either dealer tenants or just dealers that we talk to on a regular basis. I think that will be pretty transparent on how it comes back. And again, this is going to be very this distribution model that is in place is incredibly important for the OEMs, and they've got product they want to get out the door and in its driveways. Okay. And then And the other comment is it's still I mean everyone focuses on new cars. But the other aspect is there is a lot of off leases that are occurring right now. By that I mean end of lease product that will come on. There's going to be a significant amount of used cars out there. And I'm going later today once this call is done to get my winters finally off my car. A lot of people have been deferring their maintenance, whether it's winter tires or overall. And that you can defer, but you can only defer it so long. So whether it's service, used car or certainly the OEMs pushing consumer programs to get people back into the dealerships, all of that we expect to have good results. Yes. So a lot of, I guess, suppressed activity for now. And then just, I guess, beyond deferrals, so far, have you had any discussions of just negotiating the lease terms altogether? Our average term is 13 years. So certainly if I was another REIT and I had a tenant coming up in 6 months or 2 years, that would be significantly part of our discussion. I don't know if I want to trade off years, call it 2014 2015 to give someone free rent right now. That's a trade off that we well, I know what my answer is. I don't really want to do that. So if it's near term, it certainly would make sense. But if it's longer term, I don't see I see this as helping them through a bad quarter and then carry on for the next 13 years on average. So we certainly like the idea that working with them today should allow us to work with them in the future, But restructuring leases beyond the deferral amendment, it doesn't really make sense right now. The length of the term is too long. Right. Okay. That's all for me. Thank you. Thank The next question comes from Kyle Woolley at National Bank Financial. Please go ahead. Hey, good morning. Good day, Tal. Just wondering in your conversations with all the tenants, what are the things that might get in the way of a recovery there? Like I'm wondering about inventory positions for new cars. Like any concerns about some of the operational factors that might get in the way of them bouncing back nicely? No, I mean, on the operational side, not really. In some ways, they're going to use this potentially to lean more on technology and less on same level of employment. So that can save them some overhead. But really what it's coming down to is everyone's watching the strength of the underlying economy. Is it going to be more used car purchases, People are worried about their job. Is it going to be continuing on their existing car and servicing it more? And this is not or was not to start with an economic situation. So therefore, how quickly does the consumer get confidence back? One of the normal factors that would slow things down would be higher interest rates. I can say they're not worried about that nor are we, because a lot of consumers look at their car as a monthly expense. And then there's the consumer behavior or the general population behavior coming out of this. Public transit is going to be way down. Only so many people who live in the suburbs are going to be willing to jump on their bike and pedal down to their office. Everyone's going to want a bit of a bubble. Now whether that's a used car or a new car, in both cases, a lot of the time that will come through the dealership. So I think there is going to be some behavioral changes. And I think more people are going to want cars. I'm kind of curious downtown how they deal with the parking. But this is going to have some changes, but one of the changes is going to be that people do want their own space and that probably means cars. Okay. And then obviously when you go through kind of an event like this, it's a bit stressful kind of experience. Sometimes you come through this and go, okay, like there were some things I might wish I had done differently in setting up in the way I'm set up. Like has this process sort of caused you to question anything? I don't know whether it's talking about leverage or inflation index leases versus non inflation index leases, like anything through this process that's made you have you learned anything about some of those big picture elements of the lease that you might want to change going forward? Sure. And the first one is probably, I'd love to say it was planned, but it was an eventuality, which was we did a December 2019 raise because we had good momentum and we believe that we would have a very busy 2020 on the acquisition. That ended up delevering us and giving us financial flexibility, which has been a great situation, all things considered. So everyone talks about making sure you have lower leverage, so you have flexibility. And then the flip side when they're talking about lower leverage is when you've got lower leverage, it allows you to jump in when there are opportunities because of a mismatch in the market. So certainly, whether it's COVID or something else, there are times of mismatch. And that's why I kind of said before on the buy sell that there's sometimes a gap. So when does that gap narrow? What opportunities are going to be ahead for us? That December 2019 raise, it was done for one reason, but I'm really happy we did it for a whole other reason now. So other than that, no, I mean, it's reaffirmed some of our thoughts, which is also a good thing because we do some retrospect on whatever we're doing right, what are we doing wrong, do we want to do more of, what do we want to do less of. So there's been some it's good that we have good quality real estate and good streets. And it's good that we're working with groups that are going to be involved in the consolidation going forward. Okay. Thanks very much gentlemen. Thank you. There are no further questions. I'm sorry, you do now have a question, a follow-up from Brad Sturges at IA Securities. Go ahead please. Hi there. Just on that front end. So does that mean you're on the leverage side from a on a longer term basis, are you thinking of having a lower leverage target going forward? I think we talked about end of 2019 that we're looking at pulling it back a bit from the kind of mid-50s to the low to mid-50s. We do believe there's going to be opportunities ahead. I don't think we're popping back up to that tomorrow. But when there's opportunities ahead, I think we still like the idea of gradually increasing sorry, gradually decreasing our LTV, but at the same time is driving AFFO per unit up. If we can do both, that's the ideal world. And that's kind of what we strive to do, continue lowering 1 and increasing the other. Got it. Okay. Thanks for the color. Thanks. There are no further questions. You may proceed. That's great. Thank you everyone and we will talk to you shortly. Stay safe. Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.