Earnings Call: Q2 2019

Aug 15, 2019

Earnings release

Good morning, ladies and gentlemen, and welcome to the Automotive Properties REIT 2019 Second Quarter Results Conference Call and Webcast Conference Call. At this time, all lines are in listen only mode. Following the presentation, we will conduct a question and answer session. This call is being recorded on Thursday, August 15, 2019. I would now like to turn the conference over to Milton Lam, Chief Executive Officer and President. Please go ahead. Great. Thank you, Jessica. Good morning and thank you for joining us. With me on today's call is Andrew Callera, our Chief Financial Officer. Our financial statements and MD and A for the quarter are available on our website and on SEDAR. Please be aware that certain information discussed today may be forward looking and that actual results could differ materially. We'll also be discussing certain non IFRS measures. Please refer to our SEDAR filings for additional information on both our risk factors and non IFRS measures. We had a strong Q2 financial performance with continued advancement in our acquisition program, diversification, completion of a bought deal equity offering and extension and increase of our credit facilities. This allows us to be well positioned for continued growth. Our acquisition program is driving significant growth in each of our key performance measures. In comparison to our Q2 a year ago, our property rental revenue was up 44.4% with cash NOI increasing by 47.2%. AFFO was up 36% and AFFO per unit increased by 11.2% demonstrating the accretive impact of our acquisitions, which is a primary objective. This growth also reflects the continuing benefit of the long term contractual rent increases across our portfolio, which provides certainty of increased cash flows regardless of the acquisition environment. The 1st 6 months of 2019 was our most active period for acquisitions to date compared to the same period in prior years. During the Q2, we completed the purchase of a portfolio of 3 automotive dealerships from AutoCanada for a price of approximately $30,400,000 These three properties include Abbotsford Volkswagen in Abbotsford just outside of Vancouver Guelph Hyundai and Wellington Motors, a Chrysler dealership, both located in the Guelph Kitchener Waterloo area of Southwestern Ontario. The respective dealership tenants have each entered into a 19 year triple net lease, which includes a contractual annual rent increase after year 1 based on respective provincial CPIs. AutoCanada Holdings has provided an indemnity to APR in respect to their lease obligations for the 3 dealership properties. This was our 3rd transaction with AutoCanada and we're pleased to continue building our relationship with them and to further strengthen our asset base in close proximity to the Greater Vancouver and Greater Toronto areas. We've also entered an agreement with Dilawri Group to acquire the Audi Queensway dealership property for approximately $36,500,000 Audi Queensway is a newly constructed 65,000 square foot dealership facility located on 2.4 acres at the intersection of Highways four twenty seven and the Gardiner Expressway, 2 of Canada's busiest freeways. We expect this transaction to close later in 2019 subject to customary closing conditions. These transactions built upon the 2 dealership properties we acquired in the Q1 in another portfolio transaction with AutoCanada. Further, our development property in Kitchener Waterloo became an income producing asset in Q1 with the tenant Tesla Motors opening recently in the premises. In aggregate to date, in 2019, we've added more than 200,000 square feet of GLA to our portfolio through acquisitions and the opening of the Tesla Center. This figure does not include the pending Audi Queensway acquisition. This represents a 10.3% increase in the size of APR's GLA footprint. Through this growth, we have continued to enhance the diversification of our tenant base and our geographic presence in strategic markets across Canada. And we continue to strengthen our profile within the automotive dealership community. Our portfolio includes 6 of the top automotive dealership groups in the country as tenants including the 3 largest groups by dealership count. During Q2, we also successfully completed a bought deal offering raising gross proceeds of approximately $84,000,000 thereby further enhancing our capital market liquidity. The net proceeds were partially used to repay debt including the amount incurred to fund the purchase price for the most recent AutoCanada acquisitions. The proceeds from the offering will also be used to fund pending the pending Audi Queensway acquisition. At quarter end, our debt to gross book value was 49.7 percent down from 56.3% at the end of Q1. This allows us to be well positioned to continue advancing our value enhancing acquisition program. I'd now like to turn it over to Andrew Kalra to review our financial results in more detail. Thanks, Wylton, and good morning, everyone. Property rental revenue increased to $16,400,000 in the quarter, an increase of 44.4% from Q2 2018, reflecting growth from properties acquired subsequent to Q2 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 13 $100,000 $9,000,000 respectively compared to approximately $8,900,000 for both in Q2 a year ago. The 47.2% increase in cash NOI was primarily attributable to the properties acquired subsequent to Q2 a year ago. In addition to our regular annual contractual rent increases, the 1.5% increase in same property cash NOI reflected rent escalations of 10% on 3 investment properties, which occurred in Q3 a year ago. G and A expenses for the quarter were approximately 6.1% of our cash NOI, down from 7.2% in Q2 last year, reflecting the operating leverage in our management platform as we continue to add assets to our portfolio. Net income for the quarter was $8,400,000 compared to $5,300,000 in last year. The increase was primarily due to the growth in NOI, fair value adjustments for Class B LP units netted with fair value adjustments for interest rate swaps, partially offset by higher interest rate expense and other finance charges. FFO for the quarter increased to $8,800,000 or $0.272 per quarter diluted compared to $6,600,000 or $0.252 per unit in Q2 last year. AFFO was increased to $7,900,000 or $0.247 per unit diluted compared with $5,800,000 or $0.222 per unit diluted in Q2 last year. The REIT paid total distributions of 6 $400,000 to unitholders or $0.201 per unit in the quarter representing an AFFO payout ratio of 81 point 4%. This compares to an AFFO payout ratio of 90.7% in Q2 last year with the variance partially attributable to the positive impact of the acquisitions. Please note that the equity offering that closed on June 20 had a minimal impact on the Q2 AFFO twenty nineteen payout ratio. For Q2 twenty nineteen, there was a fair value gain adjustment of $963,000 primarily attributable to NOI increases, partially offset by transaction costs related to the Wellington Motors, Guelph Hyundai and Abbotsford property, a VW property acquisitions. REIT's valuation inputs are supported by quarterly market reports from an independent appraiser, which indicate no change in capitalization rates for the REIT's markets REIT since year end 2018. The overall capitalization rate applicable to the entire portfolio remained at 6 point 6%. I'll conclude with a review of our liquidity and capital resources. At the end of Q2 this year, we increased the amount of illiquid drawn under 1 of our credit facilities, facility 2, by $29,700,000 to a total of $102,200,000 and extended return maturity from June 2022 to June 2024. We also entered into $29,700,000 of 10 year interest rate swap at a rate of 3.5%. As a result, we have a well balanced level of annual maturities with interest rate swap terms between 3.5 9.3 years and our weighted average interest rate term increased to 6.5 years, up from 5.8 years at the end of Q2 last year. The REIT had $418,700,000 outstanding on its credit facilities at the end of the quarter with an effective weighted average rate on debt of 3.78%. As Milton noted, the REIT's STACK GBV was 49.7 percent, providing us with financial flexibility to continue advancing our growth objectives. I'd like to turn the call back to Knowlton for closing remarks. Thank you. Great. Thanks, Andrew. Looking ahead, we will remain focused on taking advantage of dealership industry consolidation and expanding our portfolio with high quality properties in strategic metropolitan markets across Canada, while increasing AFFO per unit in support of distributions. The Canadian automotive dealership industry continues to consolidate, So dealership owners who want to participate need access to capital. We are widely recognized as an attractive alternative to conventional debt financing. And for those dealership owners who are looking only to generate liquidity from their businesses, either for succession planning or to invest in upgrading their facilities, we represent a great way to accomplish their objectives without burdening their business with incremental debt. We'll continue to focus on high quality properties in major markets, most notably the Vecton markets, which represent more than 80% of our GLA. We are well positioned to continue building fair sorry, continue building value for unitholders and we look forward to updating you on future developments. This concludes our results and would now like to open up the lines for questions. Jessica, please go ahead. Thank you. Ladies and gentlemen, we will now begin the question and answer Your first question comes from Mark Rothschild of Canaccord. So you have the chart and the information in your disclosure on how auto sales are trending. And when we look at it lately, I'm just curious, if that has any impact in any way on your operations or anything that impacts REIT at all considering the length of the leases you have and as far as the LARI at least a strong credit profile? Yes. Good question. Short answer is no. We have triple net leases. We are not part of any sort of percentage rent participation in any sort of operating profits. Certainly, new car sales is the headline. It's the easiest thing to track. But by far the vast majority of profits are actually in the service used car and F and I world. I'd certainly encourage you and everyone else to look at the performance of the major auto groups, public auto groups out of the U. S, you'll see that over the last 24 months as sales have declined, their profits have actually been steady and done extremely well. And certainly, if you look at the unit prices, they're up 50% over 50% since January 1 this year, as the market recognizes how resilient the automotive dealership model actually is, so looking beyond new car sales. Okay. Thanks. And in regards to the acquisitions, you've obviously been somewhat active and obviously these acquisitions are very different. I wonder if you could talk about like the range in cap rates that you're getting and that you're seeing and to what extent does location matter when you're signing a lease for such a long term lease where maybe the residual value of the land is not as significant? Sure. I mean, since 1991, I've been real estate. So real estate matters to me. Real estate matters to the REIT. So it does have an effect. Certainly, Greater Vancouver, high quality locations like adjoining corner or across the 427 from Sherwood Gardens. All of that is good. You're right in the fact that we have long term leases with embedded growth. So we don't have to worry about it, but we do. We like the fact that the underlying land has value and I actually believe that value will continue to trend in the right direction. As far as cap rate range, we're still seeing that 6.5% to 7.5% world. And last year, we tried to push that up a bit and we were somewhat successful as interest rates went up. Now that interest rates have gone down, it was tough to push it up and we're fortunately not having to push it down dramatically this year either. So it's been pretty consistent. Okay, great. Thanks so much. Your next question comes from Jonathan Kelcher of TD Securities. Please go ahead. Thanks. Good morning. Good morning, John. First, just on the Audi Queensway, when do you expect that to close? Short answer is as soon as possible. Longer answer is because it's new construction, there's a couple of moving pieces. And as soon as those are cleared, we will look forward to closing as quickly as we can. Certainly, it's up and operating. And if you walk through it, go buy yourself an Audi, it is a spectacular facility. So we have the equity on hand and we'd like to deploy that as soon as possible. Okay. So you think it's a Q3 event? Some of it's beyond our control. We certainly hope so. And we'd look for it to be that. But as I said, some of it is beyond our control. Okay. Fair enough. And then summers historically are, I guess been a quiet period for you. You guys have been doing this for a while now. What's your sense on how dealer M and A is shaping up for the fall this year? Our sense is that dealers still enjoy their lifestyle and enjoy sitting on a dock during the summer. We're going to see people get back to work, back to school in September. Traditionally, what we've seen is people put their toe in the water for M and A in early in the year and it kind of slides. And then in the late kind of Q4, you see everyone kind of get back to work and try to finish off some of their strategic initiatives that they talked about earlier in the year. Either that is kind of vendors moving their price down and getting more realistic or the acquisition groups deciding that they certainly have initiatives and assets that they want to acquire and moving a bit as well. So you're right in the fact that the summer is always a bit quieter. It's more contemplative than action. And that does have a residual effect for the REITs on the activity level. Okay. So, you're hopeful that you'll be active in the back part of the year? It was certainly one of the reasons why we wanted to have the liquidity and availability to continue to take advantage of opportunities. And as mentioned before, we like doing those opportunities alongside of M and A. It allows us to achieve yields that we find are very worthwhile. Okay. Thanks. I'll turn it back. Thank you. Your next question comes from Matt Logan of RBC. Please go ahead. Good morning. Good, Matt. Just following up on Mark's question, can you talk a little bit about the resilience of the dealership model and how APR is positioned to deliver steady operating performance and income through the cycle? Sure. I mean, we like to and fortunately are seeing our dealership tenants continue to be very profitable. That profit, I would say, can ebb and flow depending where we are in the economic cycle and specifically where interest rates are. As you've seen interest rates go up, especially in the States, last year that kind of pulled back some sales because retail is a leverage type. Retail auto sales is geared towards consumer leverage. And as that gets more expensive, you'll see people pull back from new cars and go and look at more used car facilities sorry, used car assets or continue owning their existing car while longer and doing service. So if you look at some of the disclosures on the U. S. Operating codes that are focused on dealerships, you'll see that their used car focus has gone up as has the used car profitability. Same sort of comment for F and I and service. We expect that to continue to be a bit cyclical between the 4 categories. But what we really like about it is what you lose in one category, you often gain in another, which allows them to be nicely resilient on profitability, even if revenues do ebb and flow a bit. So as far as the REITs, we continue to feel very confident in the quality of A, dealership operators and B, flags that those dealerships are having in the markets that we own the real estate in. So yes, we still feel very good about what we're seeing from our dealer operators and what we're seeing in the overall market. Appreciate the commentary. Maybe just changing gears a little bit in terms of a few housekeeping items. The cap rates for some of your recent acquisitions, should we be thinking about your transactions in Guelph and Abbotsford towards the high end of your range and the one in Toronto kind of towards the lower end? Toronto, that would be a fair comment. I mean, Abbotsford, they're expanding the highway. It is now very similar to, call it a Barrie in Toronto. It's becoming a commuter market. It borders on the official Greater Vancouver area. So we're off by a couple of few miles on that, but not a lot. It is BC Vancouver. I wouldn't say Vancouver pricing, but it's more like Vancouver pricing. So I would say that's I think we got it as part of a portfolio deal with Guelph So you can play with a little bit of the allocations. But I would say you're right in the fact that Guelph KW is slightly higher. I would say Abbotsford is kind of in the mid range and a trophy asset like Queens Royalty has to and should be in the lower range. Appreciate the commentary. And in terms of transaction volume in the back half of the year with about 90 odd $1,000,000 of committed acquisitions so far. Do you think we'll surpass 2018 in terms of potential volume? Portfolio sales give us the advantage of a real boost. So it really depends if we see a portfolio coming forward and crossing the line in 2019. Without a portfolio, you'll see that our acquisitions outpaced what we've seen in 2016, 2017 2018 without the Miren's portfolio at year end. So we continue to go in very much the right direction as far as acquisition momentum. But to get over last year's number, I would think there has to be some sort of larger portfolio like deal. And last one for me, just in terms of what rates you guys are seeing on new debt with yields pulling back? We're seeing 7 year money is about 3.3 to 3.4 and 10 year money is about another 10 basis points higher than that. Yes. That's bittersweet for us because the end of the last year we were incredibly happy at where we were able to place our debt considering where we had modeled it for the acquisitions. So we felt good for about 2 months and then debt continued to get cheaper. The good news is at the average rates that we have that's very nice in the marketplace, but certainly the rates continue to go down. So that certainly helps us on the debt that we'd be looking to place in the future with some existing unencumbered assets and future acquisitions. Or some of the ones that we may want to extend as well. Absolutely. Thank you, both. That's all for me. I'll turn it back. Thank you. Your next question comes from Mario Saric of Scotiabank. Please go ahead. Hi, good morning. Good morning, Joe. Milton, I think you mentioned that APRs view you as an attractive alternative to conventional debt financing with dealers that are looking for capital. Curious how the substantial decline in the bond yields impact that decision for them? Like how sensitive is that decision to the prevailing cost of financing? Our biggest competition is the banks, for acquisitions because of the cost of debt. Having said that, it's not a moment decision. What we saw in 2018 reminded dealers that money can cost them, that debt is not always free. So the fact that it went up and you can imagine that increase has a direct impact not just on the real estate, but on their floorplan financing, which is a significant number. So reminding the community of a cost of capital and that equity is not free has certainly helped us. And I think that still remains in the minds some of the more active and more sophisticated dealers. So does that have an impact? Yes. Does it go back to where it was before? No. I think the less than gentle reminder to them last year has still lingered with them and that's helping us. Got it. Okay. And then more of a broader question. There's been a lot of press about global trade wins in the last several months. How at all, if at all, does that impact your business and your strength? Global trade wins? I certainly don't think it helps consumer confidence. I think we are slightly insulated from that in Canada. Trump is Trump and I don't know if everyone's projecting what Trump's doing because I don't know if Trump knows what he's going to do today. As mentioned before, that can affect some of the segments and quite frankly can affect some of the brands or specifically models because it really depends where they're manufactured. But I think the largest component of that is going to affect where things are manufactured as opposed to the dealership model, which is partly providing liquidity and financing for the OEMs and partly the last mile of delivery. And then finally the follow-up service. All of that will continue to be needed even if there is a bit of ebb and flow and a question mark on the global trade. Okay. Thanks for color. Your next question comes from Sumayya Hussain of CIBC. Please go ahead. Thanks. Good morning. Good morning, Ja. Can you just touch on, I guess, the CapEx plan for the Wellington Motors property and just in terms of what's the scale and timing of the development or the renovation there? It certainly is an image upgrade. We have been told that they are looking for the potential for that expansion or that they will. Sorry, need to do an image upgrade and probably a bit of an expansion. We have not seen specific plans yet because I believe they're talking about that being in the next in 2021. So we have the allocation. We certainly have it bracketed and that is geared towards a minimum or a spread, the greater of a minimum cap rate or yield attached to it or spread between that and bonds. Not that I expect bonds to move up dramatically, but it's nice to have that protection. So we're waiting to see the plans from them on exactly what they're going to do. And remember, a lot of this has to do with discussions between the OEM and the specific dealer on what they can agree needs to be done. I always find when it's back of the house, the service area, it's very much driven from the operator because there's significant profits out of service area. And if it is a newer, shinier, brighter showroom, that's very much driven by the OEM. Right. And then I guess just following up on that, I mean, how often do dealerships sort of make investments of the scale? And are you seeing that shift at all in the current, I guess, auto retail environment? General rule tends to be 7 to 10 years. And that can range from change the tile to a new kind of exterior image upgrade to something more significant. It also tends to be each brand will have times when they push a new reimaging. So you can see, you know, Toyotas kind of go through a cycle all at once. And then a few years later, you'll see Audi do it. And a few years later, you'll see Mercedes do it. Certainly, sometimes they overlap, but it tends to be very brand specific on when there's a push. And then at the same time, you'll see kind of ebb and flow with dealers on when they can agree with the OEM when that needs to be done. So there's certainly moving pieces there. General rule is 7 to 10, but that doesn't always mean significant. That can be anything minor to something that is significant. Great. Thank you. There are no further questions at this time. Please proceed. All right. Well, thank you, everyone. We look forward to talking to you again after Q3. Have a good day. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.