Earnings Call: Q2 2020

Aug 5, 2020

Earnings release

Good morning. My name is Marie, and I will be your conference operator today. At this time, I would like to welcome everyone to CTE REIT's Q2 2020 Earnings Results Conference Call. The speakers on the call today are Kevin Silver, Chief Executive Officer of Citi REIT Leslie Gibson, Chief Financial Officer of CitiREIT and Kevin Salzberg, Chief Operating Officer of CitiREIT. Today's discussion may include forward looking statements. Such statements are based on management's assumptions and beliefs. These forward looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see CTTREIT public filings for a discussion and these risk factors, which are included in their 2019 MD and A and AIF, which has been found on CQ REIT website and on SEDAR. I would now like to turn the meeting over to Ken Silver, Chief Executive Officer of CTE REIT. Please go ahead, sir. Thank you, operator, and good morning, everyone. Thank you all for joining us for CTE REIT's Q2 2020 investor conference call. For the past 5 months or so, we have all been living with the implications and consequences of the global pandemic on public health, the economy and society at large. It's an understatement to say it has been a challenging time, and we've all been dealing with circumstances we could hardly have imagined. Like the stages of grief, I'm sure we have all experienced at various points some degree of denial, anger and depression over this time. At this point, with the vaccine still only on the horizon, we are learning to accept the situation and how to live with the virus. Like all of you, the management team at C. T. REIT has been dealing with the twists and turns of this crisis. Our initial focus was on the health and safety of our employees, our tenants and our tenants' customers and employees. Preserving liquidity was also an immediate priority. As the impact of government restrictions was felt by our smaller and more vulnerable tenants, we engaged with them to understand how we could help them survive the crisis, even before the federal government announced the SECRET program, which we are participating in. While we couldn't have imagined a global pandemic and the toll it would take, we have long managed CTEIT in a conservative fashion, pursuing a low risk growth strategy, building a strong balance sheet and steadily improving our credit metrics. Our strategic advantage has always been our relationship with Canadian Tire, one of the strongest and most resilient brands in Canada. Like many of you, we have moved from immediate crisis management to managing the new normal. We will continue to run the REIT in a conservative manner and are looking to the future. We have better visibility to consequences of the pandemic on our business and are pleased with, but not surprised by our solid results. And while significant risks remain in the external environment, we are cautiously moving forward. We are planning for the future and open to making new investments, but are in no rush to do so. Our resilience, our strong balance sheet and liquidity, coupled with our positive results, have given our Board the confidence to declare a 2% increase in our distribution, effective with the September payment. It strikes the appropriate balance of prudence and optimism required in these challenging times. With that, I'll turn things over to Kevin and Leslie to discuss our Q2 results in more detail. Kevin? Thanks, Ken, and good morning, everyone. As disclosed in our press release, in the Q2, CT recompleted the expansion of 3 existing Canadian Tire stores in Kincardine, Ontario Rouen Noranda, Quebec and Yarmouth, Nova Scotia as well as the redevelopment of a multi tenant property that includes a newly built Canadian Tire store in Niagara Falls, Ontario. In total, CTE REIT invested approximately $36,000,000 in these previously announced projects, which added 288,000 square feet of incremental GLA in the quarter. On a year to date basis, CTE REIT has invested approximately $79,000,000 in previously announced projects and added 438,000 square feet of incremental GLA. At the end of the second quarter, CTE REIT had 15 properties that were at various stages of development. These projects represent a total committed investment of approximately $187,000,000 upon completion, dollars 57,000,000 of which has already been spent to date and a total incremental gross leasable area of 780,000 square feet, nearly 94% of which has been pre leased. Over the next 12 months, the REIT anticipates spending roughly $54,000,000 on these development projects. As at June 30, 2020, CTREIT's occupancy rate was 99.3%, which was slightly above the occupancy level of 98.7% as at Q2 2019. We continue to closely monitor our portfolio and engage with our tenants regarding the state and health of their businesses. With respect to the impact of the COVID-nineteen pandemic on our property operations in the quarter, tenants representing approximately 98.5 percent of annual base minimum rent fulfilled through July 1 financial obligations to the REIT, compared to 97.7% for June 1, 96.5% for May 1 and 97.8% for April 1. The REIT continues to work with tenants facing financial challenges as a result of the pandemic and where possible is participating in the Canada Emergency Commercial Rent Assistance or SECRET program, which provides a 75% rent abatement for qualifying small businesses for the period from April 1 to August 1 sorry, August 31, 2020, of which generally 2 thirds is paid for by the federal and provincial governments and 1 third is funded by the landlord. We have been working our way through the SECRA process and expect to submit applications for the months of April, May June for approximately 100 of our tenants. With respect to the recently announced July August extensions to the program, we will work with our tenants on a case by case basis to determine where participation in these additional months is warranted. Leslie will shortly go into the details of the financial impact related to the secret program. Lastly, aside from the temporary operating restrictions and or closures in some jurisdictions in the Q2, all Canadian Tire retail stores returned to full operations as of May 9, 2020, and there have been no rental interruptions, abatements or deferrals regarding the REIT's tenancies at these locations. Although we have been spending a large amount of time and effort assisting those of our tenants that currently need help, we are extremely pleased with the strength and reliability of our cash flows, primarily derived from our portfolio of largely investment grade tenancies. As Ken noted in his earlier comments, this position of strength allows us to patiently wait for the right opportunities as we navigate our way through these unprecedented times. With that, I will turn it over to Leslie for a review of our financial results. Thanks, Kevin, and good morning, everyone. In light of the backdrop of the pandemic, we are very pleased with the Q2 2020 results with reported diluted AFFO per unit of $0.256 which increased 2.8% compared to $0.249 per unit in Q2 of 2019. Diluted FFO per unit increased by 1% to $0.294 versus $0.291 in Q2 of 2019. Reported net operating income increased by $2,800,000 or 3.1 percent in the current quarter compared to the prior year. The primary contributor for the increase in NOI growth was the acquisition of Incubriducing Properties and properties under development completed in 2020 2019, which contributed approximately $1,300,000 Same store NOI increased slightly by $600,000 or 0.7 percent in Q2 2020 compared to the prior year. Same property NOI increased by $1,500,000 or 1.6 percent compared to Q2 2019 and was driven by several factors. Contractual or annual rent escalations of 1.5% on average contained within the Canadian Tire store leases, which contributed nearly $1,700,000 to NOI growth. Intensifications is completed in 2020 2019, which contributed roughly $800,000 as well as a reduction in the property management expenses, partially offset by the bad debt expense related to the rent relief under the CEQA program and further expected credit losses together, which totaled approximately $1,400,000 Further to what Kevin noted earlier, I would like to take a moment and provide more details on the impact the pandemic has had on our Q2 financial results. Credit losses of $1,400,000 were recognized in the quarter consisting of $500,000 related to the landlord portion of the Seacra program, dollars 200,000 in abatement of gross rents for tenants who did not qualify for Seacra, an additional $700,000 in additional estimated credit losses related to tenants who have been significantly impacted by the pandemic. From a rent collection perspective, approximately 97.3% of Q2's rent has been collected from tenants. In addition, we anticipate a further $900,000 or 0.7 percent of rent to be collected from the government through the SECRET program, which would bring the total rent collection for Q2 to 98.0 percent. Of the remaining 2%, about 0.6 percent of the revenue has been deferred and 0.4% relates to the landlord portion of the secret program of the tenant abatements I just mentioned. Rent collection for the month of July is again extremely strong with 98.5 percent of rent having been collected from tenants. With respect to G and A expenses, in Q2 2020, G and A as a percentage of property revenue excluding fair value adjustments amounted to 2.0% versus 2.4% for Q2 2019. This decrease was primarily due to the decrease in the service agreement as a result of the in sourcing and new ERP system implemented in Q2 2019. Now turning to our liquidity and financial condition for the quarter. The interest coverage ratio increased to 3.50x as of Q2 2020 compared to 3.35x for the same period in 2019. The increase in interest coverage ratio is due to both the decrease in the interest expense and an increase in NOI in the current quarter compared to 2019. As mentioned during our Q1 earnings call, CTE reset the rate on 5 series of Class C LP units totaling $252,000,000 for a 5 year term at 2.37 percent commencing May 31, 2020. Our weighted average interest rate decreased to 3.87% as of June 30 as a result of the reset. The REIT has no further debt maturities until the Q2 of 2021. We believe that we are well positioned to manage through these unprecedented times and pleased with the strength of our balance sheet. Our conservative 77.3 percent AFFO payout ratio, a low debt to gross book value of 42% and approximately $320,000,000 available through our committed credit facilities and cash on hand. CTE REIT's assets with an IFRS value of approximately $6,000,000,000 or 97 percent unencumbered. In addition, as of June 30, 2020, book value per unit was $14.67 which is slightly higher than our Q1 2020 value of $14.60 and the 2019 year end value of $14.61 as net income exceeded distributions. Included in our net income in Q2 was a $5,000,000 fair value decrease, which brings our year to date fair value decrease to $29,000,000 The decrease in fair value is a result of slight increases in the overall capitalization rates that were made across our portfolio. The strong covenants in our largely investment grade portfolio and our high level of rent collection throughout the pandemic continues to support the underlying property cash flows and results in valuations. We continue to monitor the market for data points related to similar essential needs net lease retail assets, we will make further adjustments if necessary based on comparable transactions if and when deal volumes return to a more normalized levels. And with that, I will turn things back to you, Ken. Thank you, Leslie. I know it's a busy time for many of our listeners. So I'll turn the call back to the operator now for any questions. Thank you. The first question is from Sam Damiani from TD Securities. Please go ahead. Your line is now open. Thank you. Good morning, everyone. Congratulations on a solid quarter and great to see the distribution increase, particularly through this time of great uncertainty. Absolutely. And when we look just look at the quarter, it was interesting in a couple of ways, one of which was the fact that no new investments were announced this quarter. And I think this is the first time the REIT has had that since the IPO 7 years ago. I wonder if you could just tell us what that says and if you're thinking about Canadian Tire and its real estate strategy perhaps changing given the acceleration of trends that we've seen over the last 5 months? Do you see the REIT sort of changing in the way it relies on Kate and Tyre for growth going forward? Sam, let me kick things off. It's Ken. I wouldn't read too much into what you've observed. To the extent that obviously with the disruption of the pandemic, basically all real estate transactions are kind of ground to a halt. Liquidity was at a premium or at least a focus on liquidity in the short term. And of course, the team has been heavily involved in working with tenants and managing the way through the secret program. So that there has been a pause in the investment activity, I think, would simply be to be expected as a result of all this disruption. I don't imagine or expect that there would be any material ongoing changes at least in the sources of growth we see. I can't comment right at the moment in terms of quantums or make any predictions. But in terms of the sources of growth, whether from Canadian Tire or elsewhere, I don't see any fundamental changes. Okay. That's helpful. And just on the leasing market, obviously, it slowed down quickly in the spring. Kevin, are you seeing any evidence of resumed activity, tenant interest when you look at leasing up some of the spaces in the developments that are still vacant? Not really, Sam. I mean, I think everybody is still fundamentally on pause. A couple of groups out there nosing around with longer term projects. Most of the lease activity we've been doing has been on the renewal front, where tenants who are comfortable and obviously managing their way through this are extending their leases. On the industrial side, obviously, we have 11 Dufferin. There has been we have a short term tenancy in there that's coming to an end. So there's actually been a pickup in showings and lease activity there. We don't have anything specific to report, but mostly end users or 3PLs that are still looking for space. But yes, just as a broad comment on retail leasing, I think it's still quite slow right now. Thank you. My last question perhaps for you Leslie, just looking at the $300,000,000 credit facility with Canadian Tire that was arranged, I think, late last year. Could you just remind us what the purpose of that is and why you don't include it in your liquidity availability? Sam, it is an uncommitted facility with Canadian Tire. So from our perspective, that's why it's not included in the liquidity calculation. It would be at their discretion when we looking for money whether they had any or whether they said yes or no. So, that is why it's not included. And really the reason for doing it and yes, it was done in Q4 last year, was really looking at just having other sources of financial flexibility from the corporation and being able to borrow from different sources should we need that at various times during the year. Thank you very much. I'll turn it back. Thank you. The next question is from Himanshu Gupta from Scotiabank. Please go ahead. Your line is now open. Thank you and good morning. Good morning. So just to follow-up on the overall market activity. So have you seen any changes in pricing or expectations for standalone retail properties versus multi tenant properties in the last few months? I mean, do you think the risk premium is likely to change differently on these two type of properties? Hi, Himanshu, it's Kevin. Similar to the leasing market, I mean, the investment market for the most part is still frozen. There have not been a lot of trades. I mean, a couple of deals that were started pre COVID that closed more recently, but haven't seen a lot that's been sourced, negotiated and closed through the course of the crisis. I think generally, there's no data, so we're not seeing real significant moves in any direction for any type of asset. I think fundamentally, we believe the market will be kind of bifurcated into risk assets and non risk assets, and people are going to pay as much, if not more, for the non risk asset of which we think essential needs retail fits into that category. So I think generally we feel pretty good about how the valuations are going to stack up for what is really the majority of our portfolio. But obviously, it's really hard to price and predict cash flows as it relates to larger multi tenant retail assets on a go forward basis. So I think if you're going to see some price softness softness, that could be where it develops over time. Got you. And then on rent collection, the secret program has been extended for August as well. I mean, in case it was not extended, do you think the tenants are now in a position to pay, which had otherwise taken benefit from this program? I think things are improving. We've as we said in our meaning not everybody that we agreed to throw into the program for the 1st 3 months, we will continue to submit on their behalf. Business is resuming. Some tenants are coming back stronger and better than others. And some are just at the early stages of the reopening too. So, I think really overall, it remains to be seen, but I think generally we're seeing the health and financial resources of our tenant base improve as wider reopenings start to occur. Sure. And maybe just final question from me on distribution. So great to see the 2% increase. I mean, it was slightly lower than the 4% increases in the last few years. Given that the payout ratio continues to be low, very low, would you revisit your distribution policy in the coming quarters? Or just being more conservative given the circumstances? Hi Himanshu, it's Ken. As you know, distributions are declared on a monthly basis. So the Board has ample opportunity to review the business and determine the appropriate distribution rate. So obviously, it depends on circumstances. I couldn't rule anything in or out, with respect to what might be coming. I think the Board's decision to raise the distribution at this point by the 2% is clearly viewed by the Board as being both prudent and a positive reflection of the resiliency and predictability of the REIT's results. Thank you. The next question is from Kyle Willey from National Bank. Please go ahead. Your line is now open. Hi, good morning, everybody. Good morning, Tal. Let's maybe start on the financial side. Given that all in financing costs have gone in the favor of borrowers over the last few months, Do you envision trying to maybe refinance more of your debt a little bit more aggressively here, just given that the rate environment is favorable. I don't know if potentially paying some penalties to lock in those future rates might make sense. Maybe you can just walk through how that math stands in your books? Hi, Tal, it's Leslie. Thanks, Tal. We do look at that all the time and obviously with rates at sort of all time lows, that's definitely some of what you're looking at. When we look at our next scheduled maturity, which is in Q2 2021, the sort of like 2.1% coupon is still lower than current market rates. So for us, it's still costly to do that. We do look at what we could do that and compare to where rates are going to be. I think our still view and what we're seeing is that we still think the current low rate environment will continue for the foreseeable, at least short term future. We do look at that, but I think at this point in time, we're not yet rushing out to refinance those earlier, though that is something that we do take a look at every the rates do ebb and flow. And any sort of change in terms of like because you still have some outstanding intercompany debt with Tire, like you could envision a scenario here where maybe Tire would prefer for you to refinance with the public market as opposed to refinancing with them just because maybe they want to keep a little bit more capital for themselves. Any change in sort of how you expect to see that play out going forward? I think with the debt of Canadian Tire, the Class Cs, we it will really depend on what Canadian Tire's use of proceeds and what they're looking for. Obviously, they know that this is one of their points of financial flexibility that they have if they're looking for additional cash in any way, and they definitely have that in their toolkit and are fully consider that in all their different options. So I think it really will just come down to when those data rolling, what the use is for CTC. Okay. And then just lastly on the potential for mixed use development in the portfolio. I don't want to put words directly in your mouth, but maybe I could characterize it as you as a manager you guys have the management team have maybe been a bit more circumspect about the financial returns on that in the market pre pandemic. For 5, 6 months in, I realize everything's up in the air. But do you see a mix of factors changing here that might cause you to be a little bit more predisposed to pursuing more mixed use development going forward? Or does it still kind of feel the same to you? Tal, it's Ken. It's not fundamentally different and it's also not quite the same. Practically, the higher value sites in our portfolio are subject to long term Canadian Tire leases. So obviously, we could work something out with Canadian Tire as others have done with their anchor tenants. But it's not a high priority activity for us at the moment. Nevertheless, we are certainly assessing redevelopment opportunities within our portfolio. So I would say it remains a longer term value creation opportunity for the REIT and obviously dependent on a number of different circumstances including ongoing relative valuations for real estate, development risk, the tenants' preferences, etcetera, etcetera. But it is something that's on the radar screen for sure. Okay. And then just lastly, with Canadian Tire, for their distribution network, do you does the company feel like they have all of the proper space needed to service their e commerce needs at this point? And if not, is that something that you could envision The REIT playing a role in helping to develop going forward? Tal, I mean, obviously, I wouldn't I can't speak for Canadian Tire in terms of how they're managing their supply chain. But I think you could expect that we're in close contact with them on any of their network requirements, whether it's retail or distribution. And given everything that's happened in the last 5 months or so, no doubt they're reviewing their long term requirements in all respects. And we would expect to be involved in those conversations. Okay, that's great. Thanks very much everybody. Thank you. Thank you. The next question is from Jenny Ma from BMO Capital Markets. Please go ahead. Your line is now open. Thank you. Good morning, everyone. Good morning. Congratulations on a solid quarter. Thank you. Just want to ask a little for a little bit more color on the distribution and the timing, because I know CTE REIT has been on an annual increase trajectory and this is the second one that's going to be passed through this year. So could you share what was behind it? Is it really a signal to investors about the strength of CT's cash flows? And if that's the case, does it suggest that there is still potentially distribution increases to be considered next year? Or do you really view this hike as sort of a pull forward of what you may have considered for 2021? Jenny, it's Ken. I mean, I think with respect to the timing, I mean, firstly, there was no the fact that we had announced previous distribution increases at the same time was really frankly, more coincidence than something that particular or meaningful in and of itself. As I said earlier, the Board reviews its distribution policy and the business on an ongoing basis. I'd say the timing with respect to this one is clearly, it feels like we've all kind of gone through the 1st wave of the pandemic. We've seen what the implications are on our business. And it seemed like an appropriate time or the Board felt it was an appropriate time to signal its confidence in the REIT's cash flows. What might come in subsequent quarters or over the next year or so is obviously unpredictable in many different ways. So I wouldn't read anything specific one way or the other into either the timing of the distribution increase. And with respect to the quantum of the distribution increase, obviously, it's at a rate that the Board felt was appropriately cautious or prudent at this time. Okay. I can appreciate that and still a good news of that nevertheless. Moving towards the SECRA and bad debt for this quarter, I'm just wondering if you could share some color on some of the constituents of the bad debt, what the tenant profile was, was it concentrated amongst a few of the maybe larger tenants or was it more widespread? And then any color on what you might expect for Q3 would be great? Jenny, it's Leslie speaking. The secret program, it wouldn't be very many of the larger tenants. Many of those didn't meet the criteria for the Secret program. I would suggest it was more of the franchisees perhaps in fast food, it was independent owner operator businesses, restaurants, service businesses, those type of ones were probably the most impacted in our portfolio. So those are sort of more represent the 100 tenants that we had, more so than sort of any of the larger tenants that we had. Hi Leslie. Sorry, maybe I wasn't clear. I was referring to the bad debt and the credit losses for the $900,000 I apologize. I was talking about the Seagra. The DIVEDTA, I would say it's a mix. Looking at the people that were probably not in the secret program, We do have a number of other tenants across the portfolio. I would say probably more concentrated on the mid market fashion in our enclosed retail portfolio and a few of those assets that were harder hit, but would not qualify for the program. Okay. And are the credit losses related to stores that have permanently closed? No. The number of the credit losses reflect our view of the collectibility of some of the arrears. Okay. Any of their stores, obviously, as Kevin mentioned, are operating or operating are now back to operations. But some of them, we still haven't dealt with yet. Okay. And then on the secret program, has CT finished and submitted all the applications on behalf of your tenants right now? We're really focused we've submitted the vast majority, not quite all of them for the April, May June period. Obviously, as you may have read, the secret programs, the requirements for the amount of documentation specific and changing documentation, we're gathering the last few pieces from a few individual tenants to complete the applications, but the vast majority of the applications have already been submitted. There is just a few left to go for Q2. Okay. And then when we're thinking about the extension to July August, I know I think it was Kevin who mentioned that you're looking at it on a case by case basis. But as a rough proportion of what was extended for Q2, Can you comment on what that might be? Is it maybe half of the tenants may qualify for an extension into July August? Anything would be helpful. Hey, Jenny, it's Kevin. I would say in terms of rough order of magnitude, I would say slightly less than half of the initial tenant group. Great. That's very helpful. Thank you very much. I'll turn it back. We have a question from Pam Beyer from RBC Capital Markets. Please go ahead. Your line is now open. Thanks and good morning. Can you maybe just comment on what you're seeing from an acquisition perspective, the types of opportunities that are out there? And are you seeing anything in terms of or much in terms of distress at all? Hey, Pammi, it's Kevin. In terms of distress, no, not anything significant that I've seen to date. As we said in our remarks, we're being patient because for two reasons. 1, there's just not a lot out there to go after right now, quite frankly. And then also, it's got to be the right opportunity. So I think vendors and buyers are still far apart on their expectations in terms of pricing. That bidask spread is still wide. So I think just in a general sense, the opportunities, we haven't seen too much come our way just yet. But I do expect in the back half of the year, hopefully, that the market will loosen up a little and there'll be a little bit more volume on both marketed deals and off market opportunities. Got it. Thanks, Kevin. And maybe just thinking ahead to next year, coming back to, I guess, one of the earlier questions, if we look at your development schedule, it does taper off a fair bit for 2021 in terms of completions. In terms of your discussions with Canadian Tire and maybe some of the opportunities that they might be looking at in terms of expansions or redevelopments, Do you see that do you see 2021 sort of ticking back up to perhaps higher levels or more normal levels? Pammi, it's Ken. I would say that, again, I couldn't direct you to a quantum of investment. However, I would we basically are collectively on pause. I don't expect that to continue. So we will see a resumption of what I would call normal course business activities from a real estate perspective with Canadian Tire in due course. Got it. Just last one, maybe coming back to that the short term lease at 11 Dufferin. Can you just remind us what the estimated impact of that coming off would be for Q3 or on a run rate basis? Pammi, I don't have that to hand. I'll have to get back to you on that one, sorry. Okay. Thanks very much. I will turn it back. Thank you. As there are no further questions at this time, I will turn the call over to Ken Silver, CEO, for any closing remarks. Thank you, operator, and thank you all for joining us today. We look forward to sharing with you our Q3 results expected the 1st week of November. Thank you. Thank you. This concludes today's call. You may now disconnect your lines at this time. We thank you for your participation.