Earnings Call: Q1 2019

May 15, 2019

Earnings release

Good morning, ladies and gentlemen, and welcome to the Automotive Properties REIT Q1 2019 Conference Call and Webcast. At this time, all lines are in listen only mode. Following the presentation, we will conduct a question and answer This call is being recorded on I would now like to turn the conference over to Milton Lam, Chief Financial Officer and President. Please go ahead. Thank you, Jessica. And for clarification, Andrew Keller, who is with me is the Chief Financial Officer. Thank you for joining us today as we go through our Q1 results. 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 will also be discussing certain non IFRS measures. Please refer to our SEDAR filings for additional information on both risk factors and non IFRS measures. Our financial results for the Q1 2019 showcase the positive impact of our acquisition program. In recent periods, we have had excess acquisition capacity. As a result, our financials did not reflect a full period contribution from acquisitions, which had the effect of obscuring the accretive impact of these acquisitions. As we are now within our target LTV range, our Q1 per unit results are reflecting the full impact of our acquisition program. As you saw in our Q1 results, we are generating significant growth in each of our key performance measures, including accretion to AFFO per unit, one of our primary objectives. In comparison to our Q1 a year ago, our AFFO was up 32.2% in Q1 2019 and AFFO per unit increased 8.4 percent to $0.243 driven by a 38.7% increase in property rental revenue and a 40.2% increase in NOI. But it's not only the acquisitions that are driving this growth. The results also reflect the continuing benefit of our long term contractual annual rent increases across most of our portfolio. The presence of this built in annual growth in rental income provides us with certainty of increased cash flow regardless of the acquisition environment. We continue to be active on the acquisition front in the Q1. At the end of the period, we acquired McNaught Cadillac Buick GMC and St. James Volkswagen dealership properties in Winnipeg from AutoCanada for a cumulative purchase price of approximately $24,000,000 These properties add an aggregate of more than 96,000 square feet of GLA to our portfolio and will begin to contribute to our financial results in Q2. This was our 2nd acquisition with AutoCanada, one of Canada's largest automotive retailers, and it has expanded our portfolio into the metropolitan Winnipeg market, the 7th largest metro market in Canada, while further diversifying our tenant base. In line with our operating strategy, we have entered into a 19 year triple net lease with AutoCanada for both properties, including contractual annual CPI based rent increases after the 1st year. This continued diversification of our tenant base highlights our focus on partnering with leading automotive dealership operators that are active in the consolidating industry. Our portfolio includes 6 of the top automotive dealerships dealership groups in the country, including the 3 largest groups by dealership count. We've also agreed to fund a total of $6,500,000 in capital development expenses for the 2 Winnipeg properties. In return for the funds, the tenant will pay incremental monthly rent based on the amount of development expenses incurred. Also in Q1, our development property in Kitchener, Waterloo became an income producing property. The tenant, Tesla Motors, has opened the service center at the premises. We're pleased to welcome Tesla into our expanding network of 3rd party tenants. And of course, Tesla also adds to our automotive brand and tenant diversification. Our brand representation now stands at 32 global brands. But the story of Q1 2019 was undoubtedly being able to demonstrate the benefits of our acquisition program, including a very active Q4 2018. I'd now like to turn it over to Andrew Callroad to review these results and our financial position at quarter end in more detail. Andrew? Thanks, Milton, and good morning, everyone. Property rental revenue increased to $15,700,000 in the quarter, up 38.7 percent from $11,300,000 in Q1 last year, reflecting growth from properties acquired subsequent to Q1 2018 and contractual nominal rent increases across a significant portion of our portfolio. Total and same property cash NOI for the quarter increased to $12,700,000 $9,000,000 respectively, compared to $8,800,000 for both in Q1 a year ago. The 43% increase in cash NOI growth was primarily attributable to properties acquired subsequent to Q1 2018 in addition to our regular annual contractual rent increases. The 1.7% increase in same property cash NOI reflected rent escalation of 10% on 3 investment properties which occurred in August 2018. G and A expenses for the quarter were approximately 5.7 percent of our cash NOI down from 7.1% in Q1 last year reflecting the operating leverage in our management platform as we continue to add assets to our portfolio. Net loss for the quarter was $17,100,000 compared to a profit of $14,100,000 in Q1 last year. The variance is primarily attributable to the increase in our unit price as at quarter end compared to year end 2018, which reflected in a non cash change in fair value adjustments of $18,100,000 for Class B LP units and $6,700,000 interest rate swaps as well as higher interest expense and other financing charges netted with the growth in NOI. As Milton highlighted, with our LTV now within our target range and funds deployed in income producing property investments, the benefits of our acquisitions are flowing through to our cash generation metrics, including on a per unit basis. FFO for the quarter increased 28.7 percent to $8,600,000 or $0.269 per unit diluted compared to $6,700,000 or $0.254 per unit in Q1 last year. AFFO was up 32.2 percent to $7,800,000 or $0.243 per unit compared with $5,900,000 or $0.224 per unit in Q1 2018. For Q1 2019, the REIT paid total distributions of $6,000,000 to unitholders or $0.201 per unit representing an AFFO payout ratio of 82.7%. This compares to an AFFO payout ratio of 89.7% in Q1 last year, of which variance is attributable to the positive impact of acquisitions. For Q1 2019, there was a fair value gain adjustment of $300,000 attributable to NOI increases and offset by the transaction costs related to St. James VW and McNaughton Cadillac Buick GMC Property Acquisitions. The 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, the REIT since year end 2018, the overall implied capitalization rate applicable to the entire portfolio remained at 6 0.7 percent 6.7 percent 6.6 percent, excuse me. I'll conclude with a review of our liquidity and capital resources. In 2018, we increased and extended our credit facilities in 2 separate transactions providing longer term rate certainty and greater flexibility. As a result, we have a well balanced level of annual maturities with interest rate swap terms ranging between 4 10 years and a weighted average interest rate swap term remaining of 6.4 years, up from 5.8 a year ago. The REIT had $463,000,000 outstanding on credit facilities at quarter end with an effective weighted average term on debt of 3.79%. The REIT's debt to GBV was 56 0.3%, in line with our target range. I'd like to turn the call back to Milton for closing remarks. Great. Thanks, Andrew. Obviously, we're very pleased with the financial performance of the REITs in Q1 2019. Our comparative results will continue to benefit from the impact of acquisitions and contractual rent increases throughout the year. And we'll start to see the contributions from our recent Winnipeg acquisition in Q2 2019. Looking ahead, we will remain focused on taking advantage of dealership industry consolidation and expanding our portfolio with high quality properties in major metropolitan markets across Canada, while increasing AFFO in support of unitholder distributions. The attractiveness of our offering to dealership owners is underlined by the Increasing diversity of our tenants. The Dilawri Group remains The REIT's most significant tenant, but now accounts for approximately 64.1% of the REIT's base rent, including rent from properties subleased to third parties, compared with 86.7% a year ago. The Canadian automotive dealership industry continues to consolidate, but dealership owners who want to participate need access to capital. We're widely recognized as an attractive alternative to conventional debt financing. And for those dealership owners looking only to generate liquidity from their business, either for succession planning or to invest in upgrading in 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 Bechtel markets where approximately 85% of our GLA currently resides. The opportunity pipeline we're seeing is very substantial. And in summary, we're pleased with what we've accomplished. We've more than doubled the size of our portfolio in market liquidity since IPO. We've significantly diversified our tenant and geographic diversification, including adding some of the largest dealership groups in Canada. Our acquisition program has demonstrated AFFO accretion on a per unit basis. And this has provided APR with a comfortable payout ratio of 83%. We are well positioned to continue building value for unitholders. This now concludes our remarks. We'd like to open the line up for questions. Jessica, please go ahead. Thank you. Your first question comes from Matt Logan of RBC Capital. Please go ahead. Thank you and good morning. Good morning. How are you doing? Not too bad. Yourself? Good. On your Tesla service center, with the company operating stores directly, do you think it helps the REIT build relationships for future acquisition opportunities down the road? Anytime you work with a group like Tesla or any of the major dealership groups, I always find the first deals the hardest. So that's certainly what we think good news, whether it's service, which is a major driver for most dealership groups of income and most noticeably profits or direct retail. It's all good. And with a number of other luxury automakers launching electric cars over the next year or 2, how do you think that changes dealership footprints or real estate requirements? I don't think there's a significant impact. Certainly, we believe the electrification is going to occur. I think it's occurring slower than people predicted 5 years ago, and I think that will continue. But as we've mentioned before, the world of electrification does not mean you do not need that you don't need service. Anyone here who has an IT department knows you probably call them more for your computer than you do for your calculator. So we certainly believe that it changes the dynamic as people move forward, but not the baseline requirement for real estate. Great point. And maybe just shifting gears slightly, notice that Del Warri's debt increased to 5 times EBITDA. Can you tell us if that was a function of the new IFRS 16 lease accounting standards? And if so, what a normalized debt number might be? We didn't break it down on the IFRS or they didn't break it down on the IFRS. But the most significant reason for that is the announced acquisition of the Mercedes Benz dealerships and real estate in the Vancouver market. Obviously, that was a significant acquisition that had impact in Q1 without the benefit of the 12 months because they've only acquired it at the beginning of the year on the 12 month rolling revenue numbers. So would it be fair to say maybe looking on a prospective basis, it should hopefully be similar when we get 12 months out? We don't have that much visibility. But certainly, you would see contribution on the revenues and you would believe profit side, not just the increased debt, which obviously occurred at one time upon closing. Okay. Appreciate the color. That's all for me. Thank you very much. Thank you. Your next question comes from Jonathan Kelcher of TD Securities. Please go ahead. Thanks. Good morning. Good. Just sticking with the Dilawri's and the Vancouver acquisition, is that are those potential property acquisitions for you guys? Under the strategic alliance, they certainly have to offer them to us and have done so. At this time, we've declined. But certainly, the more active they are with the strategic alliance, that's all good news for the REIT. Okay. So they own the real estate on all those properties? I believe it's all. The major ones, yes. Okay. And is the reason you declined just a function of the pricing given the land values out there? There's always a number of factors. So we certainly reviewed it, but at this time, we declined. Okay. And then just secondly, the Dixie Auto Mall, last few quarters seems to be going through some dealership changes. Can you maybe provide a little bit of color on that and thoughts on what tenants could go in there? Yes. I mean, one of them the first one that came up, it was Kia that wanted to relocate and expand. And so they moved into a previously branded Honda dealership. That Kia space was then taken by Nissan. And now that that's completed, you're seeing Hyundai leaving, and we expect to be able to announce new tenants or I shouldn't say new tenant, new sub tenant because all of this is leased as the entire Dixie Auto Mall by Dilawri. This would not be unusual to see the dominoes that do occur. As you can imagine, over 20 years, there's different requirements, expansions, etcetera. It's one of the baseline kind of beliefs within our REIT that we will see intensification on-site. So the desire and the need for dealership groups to continue to invest and increase their premises size in major markets is very much an underlying theme within our REIT. So we expect more announcements going forward. Certainly, we can't announce until it's official for provided to us by the tenant. Okay. Now do you guys get any insight into the sales by the individual dealers there? No, we don't. I shouldn't say that. We obviously some of that is included in the carve out groups, but not on individual dealership basis. Not the subtenants. And not the subtenants. Okay. And then just finally, is the straight line rent from Q1, is that a good run rate for the remaining 3 quarters this year? That's a good run rate. But as you know with straight line, it does decline as we go, but it is a good run rate for now. And what you will see going certainly end of the year more in Q1 is some of the more recent acquisitions we've completed, including Mirans at the end of the year and the AutoCanada deals, are CPI based. So as a result, they don't have as much of a differential as of the straight line calculation. Yes, there would be no impact on the straight line for those. So anything with a TPI, we would not be straight lining them. Okay. Thanks. I'll turn it back. Your next question comes from Pammi Bir of Scotia Capital. Please go ahead. Thanks and good morning. Good morning. Just Milton and I guess Andrew, just on the new CapEx reserve, can you maybe just perhaps walk us through the decision to introduce this change? We looked at some factors that we outlined in the MD and A and we believe that at this point in time in Q1, it would be a wise decision that in place. It's 0.5 percent of base rent. Also, for the analyst community at this point in time or at beginning of the time, what is taking a reserve and it provides them with consistency and comparability. So that's the analysis that we took. And very succinctly, we don't believe that at all times it's going to be a 0. Certainly, we have triple net leases. So in history and in the near future, we don't expect anything. But I think it's responsible to have a reserve as we go forward. And until the white paper that came out with Realpac, we had previously. So we put it back in. At the same time, we removed the add back on the non cash compensation side. Right. And then I guess just on the reserve itself, would that be a reflection of both recoverable and non recoverable costs? Well, ultimately, we as a landlord are specifically responsible for structure and that's one of the components. And then the other components that we looked at was retention rates as well as lease terms. Yes. There's not a lot of non recoverable. So as a result, I would say it's more if and when we lose tenants. Certainly, we don't have near term expirations other than the 2021, but it is a reserve. So I think it's responsible to take it well before you actually need it. And as I said again, all the analysts are taking in their models. So I think it provides a lot more clarity with our analysis now. Got it. Just on the Tesla service center lease, can you just provide some color on the duration? Are there rent steps in there? And is there an indemnity from the parent? We're under a pretty strict confidentiality agreement. So we're very happy to get Tesla there. I think we announced originally the length of the term, but certainly can't talk about any of the specific terms within it. They're pretty strict that way and we're good with that. We're happy to get them on board. Okay. And then just Milton, lastly, you commented on an active pipeline for acquisitions. Can you maybe just expand on that and whether there's been any change in activity just with the deceleration of auto sales? Yes. It's certainly touching on that, both the fact that interest rates went up a bit last year means it was a real cost of capital for dealership groups. And secondly, what we've talked about before, which is if you're getting paid to do nothing, the tendency is to do nothing. So now that there's been a deceleration still healthy levels, but not the same record levels in 2017. We think that's a factor on why we're getting a bit more activity. I wouldn't say the sole factor. I think part of it is we're getting more and more known. The relationships we started previously are now coming a bit more to fruition. The fact that we had a very busy 2018 certainly removes any of the question of is this purely a single tenant REIT or are we there to work with the industry. I think all of those are good factors that are assisting us moving forward. Anything in any sort of advanced stages at the moment? We don't talk about that until we actually announce and we've always done that. Okay. Thanks very much. Your next question Just actually wanted to first start asking about the now that you're at your target sort of capital structure in terms of investment, any thoughts to moving on the payout ratio? We're happy the fact that we've got down to 82.7% just under 83%. And certainly, we have contractual rent increases that will continue moving that down. We've talked about before, we like to get that down. It certainly allows us more flexibility in a very strong footing to be flexible and have options in front of us, whether that's continuing to pay down debt, whether it's increased cash distributions or just further acquisitions. So at this point, we're happy with where it is. But going forward, it's something that we continue to look at. But we're still what I would say is in an early to mid stage REIT, and we still have some good activity, some good opportunities ahead of us. Okay. And then my next question is just on AutoCanada. They had credit rating downgrade yesterday and some concerns over refinancing some of their notes. I know you picked off select assets. And so I'm just wondering if you can talk to sort of your due diligence and underwriting on those assets as you went through them, like what makes you I'm sure you still feel comfortable on those. And so if you can just talk to some of the things you saw on those assets there that makes you feel comfortable? Yes. I mean, we feel very comfortable with them, both on AutoCanada, both on the markets and on the brands. All of that kind of layers out to make us comfortable. It comes back to the fact that in our due diligence, we certainly look at the real estate, the DIRTT location, and we look at how that specific dealership is performing and then how the indemnifier, in this case, AutoCanada is. Remember, it's very tough. It's not like traditional retailers that control 200, 300 locations and can select what they want to do with them. These franchises are very valuable on individual locations, And that provides us with comfort and nice backstop. You can't just shut them down because there's good value there. Okay. That's it for me. Thank you very much. Your next question comes from Mark Rothschild of Canaccord. Please go ahead. Thanks, Dan. Good morning, guys. Good morning. Maybe just following up and I think you said that you don't really have an answer, but as far as the Zilari's leverage number, the debt to EBITDA, let's say, do you have any indication of even a range of where it will settle out? No. I mean, a significant part of that acquisition was the real estate. And certainly, owning Mercedes Benz and all the dealerships in Vancouver for Mercedes Benz, I would believe is a very strong asset. But no, we don't have we're not provided that visibility. Okay, great. And then maybe just another question for G and A. Do you have any guidance for the year based on what you own now, what the G and A would be? We don't provide guidance, but I have said that in the past that what we disclose would be a good run rate, which we have to factor in at the end is also in Q4. G and A expenses are higher than Q1 and Q2 and Q3. So that's probably the most For natural year end expenses. Yes. That's probably the most clarity I can give you within the 2019 at this point in time. Okay. Thank you. Your next question comes from Sameer Hussain, CIBC. Please go ahead. Thanks. Good morning. Good morning, Shmaja. So you touched on it a little bit, but I just wanted to maybe have a bit more general view on just your tenant profile and the increasing diversification it's had over time. And if you can just walk us through, let's call it your vetting process for getting a handle on tenant held and what metrics you're focusing on in terms of profitability, growth, leverage? And also, how much transparency is there on an ongoing basis you can kind of continue monitor how things are going operationally? Sure. That question is a mouthful. We underwrite both the real estate and the tenant. And as importantly, on the location and the specific franchise, all of our leases have indemnification. And that indemnification is multiple locations, multiple brands. So that provides us with an additional backdrop on comfort. But in our due diligence, yes, it's a combination of the specific dealership and of the indemnifier as well on top. And on the go forward basis, no, I mean, we're a traditional landlord whereby we do not have percentage rent sales. And so therefore, tenants do not supply us with ongoing financial information. So we certainly make a decision on the way in and are comfortable with that. Your next question comes from Troy MacLean of BMO Capital Markets. Please go ahead. Good morning. Good morning, Dan. Now that you've gotten delivery down to about 64% of base rent, do you have a target of where you want that to be in the near term? And is that driving any of the decision around whether or not you want to buy a property from Delray at this time? Short answer is there's no specific target. We believe that naturally Dilawri will get to be a lower percentage and that's based on the fact that Dilawri sold us most of their existing portfolio or all their existing REIT ready portfolio at IPO. And there's a significant universe out there of none because Dilari at the time and still I believe is about 1.5% of the market share. So that certainly should mean that we've got more opportunities with other tenancy groups and that allows naturally Dilawri to get reduction on percentage. The other comment there would be we're very aligned with Dilari because of their significant position via Class As and ownerships. So we probably have more flexibility working with them on timing on acquisitions than we may with other tenants. And then I know this is probably way too early, but just on the 2021 renewal, that tenant, do they have a fixed renewal option or is it at market? It is at market. And then, how do you like is that just a negotiation or how do you determine what market price is for the dealership? It's always negotiation with the potential for an arbitration, which you hope you never get to. But certainly, I would believe that location has become better over the last 10 years. I think it'd be very tough for anyone to argue that comment. Thank you. That's good color. I'll turn it back. Your next question comes from Brad Sturges of AI Securities. Please go ahead. Hi, there. Good. I guess following up on the commentary with the acquisition pipeline, knowing that the start of the year is usually a little bit slower. I guess how would you compare what you're seeing today versus previous years? Is it a material difference in terms of the discussions or the opportunities you're seeing right now? I would think a combination of what I talked about before ends up being we're liking the start of 2019 more than any other year. The word materially is always question mark, what does that mean? But we're certainly pretty happy with what we're seeing on the macro market and what it means as far as our pipeline. And I benefit I put that benefit as timing in the market and more maturity and knowledge about the REIT. Would the opportunity be market specific or are you seeing it across all your all the victim markets? Vancouver has always been tough. Other than that, I wouldn't really say it's market specific. It's a bit broader. A lot of it's driven by discussions with specific groups and where they have strength. So it's certainly somewhat market driven, but it's a lot tenant driven as well. Okay, great. Thank you. There are no further questions at this time. Please proceed. Great. Thank you for joining us on the call today, and we look forward to speaking with you again for the Q2 results. Have a good day.