Earnings Call: Q1 2019

May 7, 2019

Earnings release

Good afternoon. My name is Anne Louise, and I will be your operator for today. At this time, I would like to welcome everyone to the Citi REIT First Quarter Earnings Results Conference Call. The speakers on the call today are Ken Silver, Chief Executive Officer of Citi REIT Leslie Gibson, Chief Financial Officer of Citi REIT and Kevin Salzberg, Senior Vice President of Citi REIT. 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 CT REIT's public filings for a discussion of these risk factors, which are included in their 2018 NDMA and AIF, which can be found on Citi REIT's website and on SEDAR. I will now turn the call over to Ken Silver, Chief Executive Officer of Citi REIT. Ken? Thank you, operator, and good afternoon, everyone. We're very pleased to welcome you to CTE REIT's 1st quarter 2019 investor conference call and to share with you the results of another strong quarter. I'm going to turn the call over to Kevin Salzberg, Senior Vice President of Real Estate to provide an update on our investing activities and operations. Leslie Gibson, our Chief Financial Officer, will then review the financial aspects of the quarter, and I'll wrap things up before turning the call over for questions. Kevin? Thanks, Ken, and good afternoon. We are pleased to start the year with strong results and the announcement of new investments this quarter totaling $33,000,000 These new projects are comprised of 1 vend in from CTC, 2 Canadian Tire store expansions and several new third party pad developments on existing CTE owned properties. Although historically we have not provided regular updates on the progress of our pad pipeline initiative, we felt that it was appropriate to relay our plans for the balance of the year based on the great work our team has been doing and the number of projects that we expect to come to fruition in 2019. In total, these investments when completed will result in an incremental 118,000 square feet of gross leasable area being added to the portfolio and are expected to earn an average going in cap rate of 7.1%. Additionally, we invested $54,000,000 in the Q1 towards previously announced investments. These projects included 3 new Canadian Tire Store development in Grand Falls Windsor, Newfoundland Mount Forest, Ontario and Grand Prairie, Alberta. The Grand Prairie location now being Canadian Tire's largest single level store in the country. The REIT also completed the redevelopment of a redundant Canadian Tire location in Calgary, Alberta for a third party grocery store, the intensification of a property in Toronto, Ontario for a 3rd party grocery store as well as the intensification of a property in Bradford, Ontario for a Canadian Tire Gas Plus Gas Bar and Car Wash. As previously disclosed, CTE REIT's investments in the quarter also included the acquisition of a standalone Canadian Tire store in Canmore, Alberta from a third party. In total, these investments increased our GLA by approximately 373,000 square feet. At the end of the Q1, CTE REIT had 28 properties under development. These properties represent a total committed investment of approximately $240,000,000 upon completion and a total gross leasable area of 1,000,000 268,000 square feet, nearly 92% of which has been pre leased. On a committed basis, our portfolio is 99.1% occupied as at the end of the Q1, a slight increase over Q4. This modest increase relates primarily to Canadian Tire leasing approximately 100,000 square feet at our 11 Dufferin Place Southeast property in Calgary, Alberta on a short term basis for additional seasonal requirements. We expect that this short term occupancy will likely only be required by CTC until the end of Q2. With that, I will turn it over to Leslie for a review of our financial results. Thanks, Kevin. Good afternoon, everyone. Before I get into our results, I would like to highlight an accounting change that has impacted our results. As you are aware, IFRS 16 on leases came into effect January 1, 2019. This new accounting standard is most impactful for lessees as the standard aligns the presentation of leased assets to be similar to owned assets, resulting in both an asset and a liability being recorded on the lessee's balance sheet. As C. T. REIT has only 10 ground leases, the impact of the conversion to IFRS 16 was relatively minimal. The adoption of IFRS 16 has resulted in the recognition of a right of use asset, which is classified as part of investment properties and a lease liability for all operating leases where CT is a lessee. I do want to highlight that IFRS 16 does not change the underlying operations or economics of our business. To ensure comparability year over year, we have adjusted the 2018 net operating income to exclude ground lease expense to achieve consistency in reporting under the new standard. The disclosure will be provided for the balance of 2019. In addition, the definitions of FFO and AFFO have been adjusted for IR 16 in accordance with the updated RealPack definitions, which consisted of a new deduction for the principal payments related to the lease liability. Moving on to Q1 results, we reported FFO per unit diluted of $0.288 an increase of 4% compared to the $0.277 per unit diluted in Q1 2018. AFFO per unit increased 5.2% to $0.245 as compared to $0.233 in the comparable period. Both increases were driven primarily by the impact of acquisitions of income producing properties and properties under development completed in 2019 2018. Reported NOI was 89,900,000 dollars for the quarter, increasing 5.4% compared to the same period in the prior year. As I mentioned, this is after excluding expenses related to the ground rent in NOI for 2018 as a result of the adoption of IFRS 16. This growth was primarily driven by the acquisition of development activity that was referenced previously, which contributed $1,900,000 to NOI growth this quarter. The same store NOI growth of 2.8% and same property growth of 3.2% were driven primarily by 2 components. Firstly, the average rent escalations of 1.5% contained between the Canadian Tire store and CTC Distribution Center leases and secondly, the recovery of capital expenditure and the related interest earned. In addition, this quarter compared to Q1 2018, there was a positive NOI impact related to the changes in tenancies at 11 25 Dufferin Place in Calgary, Alberta that occurred last year. G and A expenses as a percentage of property revenue increased to 3.9% versus Q1 2018, primarily due to the change in fair market value of C. T. REIT's unit price. If one excludes the fair market value changes, G and expenses as a percentage of property revenues decreased to 3.0% versus 3.1% in the prior year. Included in G and A expenses this quarter was approximately $400,000 related to our previously announced property management in sourcing project. I would like to note that effective May 1, we have now gone live with this project, including the implementation of our new ERP system and the internalization of property management functions related to the majority of our multi tenant assets. With the hard work and effort of the project team, including individuals from both CTC and the REIT, we've successfully entered a new stage at CTCREIT where we are much better positioned to optimize results from our portfolio and to develop internal capabilities that we believe will meaningfully contribute to CTE REIT's future. While we are still in the early stages of rolling out this project, we continue to look to ways to optimize the process from our learnings thus far in Q2 and expect that there will be a net positive change related to general and administrative expenses and property operating expenses once the transition is complete in the latter part of 2019. The balance of the project costs of approximately $700,000 are expected to be incurred in the next two quarters. Lastly, in Q1 2019, we saw an increase in interest coverage ratio to 3.35 times as compared to the same period in 2018 due to the growth in EBITDAFV, excluding this growth of interest and other financing charges as well as the impact of IFRS 16. Moving to the balance sheet, we continue to hold a strong financial position. As of March 31, CT REIT's indebtedness ratio was 44.1% compared to the indebtedness ratio of 45.1% as of December 31, 2018. The decrease in this ratio is due to our continued investing activities, fair value adjustments made to the investment property portfolio and the IFRS 16 related impact of including the right of use asset in investment properties, partially offset by an increase in total indebtedness. We also have approximately $288,000,000 available on our credit facility as well as over $8,000,000 of cash, which keeps our balance sheet in a strong and liquid position. Our AFFO payout for this quarter was 77 percent, lower by 1.3% than in Q1 2018. The decrease is mainly due to the growth in AFFO exceeding the rate of increase in our distributions. Distributions per unit for the quarter amounted to $0.189 or 4% higher than the same period in the prior year due to the increase in the annual rate of distributions affected with the first distributions paid in 2019. I would also like to speak to trend in our book value per unit. As of March 31, 2019, the book value per unit was $14.15 representing a 4.5% growth over the book value of $13.54 reported at the end of Q1 2018. The main contributing factor was the increase in our net income exceeding distributions. And with that, I'll turn it back to Ken. Thank you, Leslie. We're delighted to kick off 2019 with another strong quarter, a quarter characterized by attractive growth underpinned by a solid balance sheet and financial metrics and an increase in the distribution to unitholders. As I described at our AGM this morning, our ability to consistently deliver these kinds of results is owed to our privileged relationship with Canadian Tire, our majority unitholder and most significant tenant. In an era of retail disruption, the Canadian Tire brand, nearly 100 years old, continues to grow and evolve with Canadians, competing effectively in an emerging multi channel world, building on one of the best located and most convenient bricks and mortar store networks in the country. Let me give you a flavor for what we see from the REITs perspective. Since our IPO, we have completed or have underway the development of 11 replacement Canadian Tire stores and 5 incremental stores. The replacements have been to larger on concept stores in proven markets, and the incremental stores have been in high growth markets across the country. One of the replacement stores is in Grand Prairie, Alberta, which just opened in Q1, and as Kevin reported, is the largest one level Canadian Tire store in the country. 2 of the replacement projects will be stores relocated to larger vacant Target boxes in multi tenant assets we acquired from others, provided both growth providing both growth opportunities for the retailer and value add opportunities for the REIT. In addition to the new builds and redevelopments, we have expanded over 40 Canadian Tire stores in our portfolio. This is just Canadian Tire's development with C. T. REIT and doesn't include the company's development with 3rd parties. Canadian Tire, unlike many in retail, too burdened by debt and lack of imagination, has been executing a program of investment in digital technology and in keeping its store network up to date and relevant for customers. I love the fact that CTC considers its websites, e commerce business and consumer apps as digital properties, extending the concept of real estate beyond bricks and mortar in a multichannel world. One of the most visited websites in the country works together with a high quality network of stores located close to customers across the country, allowing Canadians to shop the way they want, whether in store, online for pickup in store or online for delivery to home. Canadian Tire's multichannel strategy together with outstanding merchandising is delivering for Canadians. Winning companies thrive in times of disruption. As the headline scream retail apocalypse, Canadian Tire keeps growing and we at CTE REIT grow together with it. Including the investments I just mentioned, we have since IPO acquired, developed or have in development almost 10,000,000 square feet of GLA and have committed approximately $1,800,000,000 pursuing a strategy linked to Canadian Tire store network, supply chain and office requirements. As many in the REIT sector turn to mixed use and high rise development, recycling capital out of secondary markets to invest in high cost urban markets, we are pursuing a different path, a path that provides visibility to predictable and growing results in a business model less challenging and risky execute. While we have embedded in our portfolio high quality urban assets and pursue select value add multi tenant opportunities, as our path diverges from our peers, CTREIT increasingly emerges as Canada's premier net lease REIT, a space we're more than happy to occupy. For our investors, this means continued focus on our key competitive advantage, our relationship with Canadian Tire to deliver reliable, durable and growing results. And now, operator, I'll turn the call back to you for any questions from our listeners. Thank you. And we do have a first question from Matt Logan from RBC Capital Markets. Please go ahead. Thank you and good afternoon. Hi, guys. In terms of Canadian Tire's digital initiatives, can you talk about your distribution center portfolio and how the REIT is helping Canadian Tire adapt its supply chain? Matt, it's Ken. As we demonstrated with the investments we've made so far, particularly the investment we made in what was formerly their Sears Canada distribution center, We're obviously more than happy to provide space to Canadian Tire for them to use. How they use the space between direct to store and direct to customer delivery or how they fulfill their e commerce strategy, we kind of leave to them. But suffice it to say that we try to stay very close to them on all elements of their real estate requirements, whether it's retail, whether it's supply chain and whether it's their office needs. And as you guys redevelop some of the former Canadian Tire stores for other purposes, Can you talk about me what makes the Canadian Tire footprint ideal for other uses? Sure. One of the things that I guess or a couple of things that distinguish the Canadian Tire buildings relative to some of our peers in the big box retail industry is firstly our stores were typically smaller on average than some of the larger players. And the dimensions of the stores were also a little bit different. So they weren't as deep as say Home Depot box or a Walmart box. And that lends themselves to either dividing them up for multi tenants or allowing them to be recycled for tenants who don't need quite as much space like a supermarket. Appreciate the color. And in terms of some of your secondary market acquisitions as your peers sell assets, Can you talk maybe what you're seeing in terms of pricing in the market? Hey, Matt, it's Kevin. I think generally speaking, we're seeing cap rates as fairly flat for the most part. In secondary markets, it's been an interesting dichotomy to see certain assets trade and certain assets not trade. So I think where vendors can get their pricing, they're happy to transact and where they don't feel they're being properly rewarded, we've seen them pulling deals. So I think cap rates are holding up but there is some tension in the bid ask spread that we're seeing as well. But suffice it to say for the types of assets the REIT owns pricing is generally holding pretty firm. Yes, I think there's that mid market space that's REITs are getting out of private investors are hopping into where there is a lot of capital chasing strong covenants, long term leases, management free assets, similar to the ones we would own for sure. Well, thank you very much guys. That's all for me. Thank you. Thank you. The next question is from Sumayya Hussain from CIBC. Please go ahead. Thanks. Hi, everyone. Hi, Somaya. Just to firstly to confirm on the temporary vacancy, our tenancy, I guess, at Dufferin Place, will the NOI contribution in Q2 be similar to what we saw in Q1? Hi, It's Mya, it's Leslie. CTC occupied the space for 1 month in the Q1 and we're expecting that CTC will probably occupy for all 3 months of Q2. So there'll be a little bit of increase for that in the Q2. Okay. And I think it was about 1,000,000 additional NOI from that tenancy? No, no, no. It's less than $100,000 a month. $100,000 Okay. Great. And then just I wanted to touch on to leverage, it's at 44%, it's pretty conservative. But there are a couple of your peers that are even lower, but maybe with slightly different business models. Any thoughts on if you're comfortable where you are right now or would you want to see it go even lower? Sumayya, I think we're very comfortable where things are right now. I think one thing that perhaps puts us in a different position is the creditworthiness of our tenant and CTC and how they're doing and how we feel about the certainty of those cash flows. So perhaps compared to some, we could be higher up in the respective, but right now in the area we're in, we're very comfortable. Okay, makes sense. Thank you. Thanks. Thank you. The next question is from Sam Damiani from TD Securities. Please go ahead. Thank you. Good afternoon. Just on the balance sheet, can you just confirm or talk about to what extent the Yonge and Eglinton asset has been maybe written up from a very fair value perspective since the original acquisition? Sure, Sam. It's Leslie. The asset at Yonge and Eglinton, as originally purchased and then subsequent purchase from air rights has basically been at the acquisition price. There's been no change to sort of the cap rate metrics we've applied to that property since we've acquired it. And presumably the NOI coming off the property is pretty stable, building is pretty stable still? Yes, it is. The NOI has gotten a little bit better, a little marginally better since the initial acquisition, but relatively stable. Thank you. Just going over to the Calgary industrial properties, obviously nice to have some temporary income, but what is the pipeline of discussions looking like for long term leasing of that space? Sam, it's Kevin. So unfortunately, we don't have a concrete update for you on the leasing progress. More qualitatively, I can say we've had several groups at the table who, I could say still may yet materialize that we've had what I describe as advanced discussions with. But all of those groups have been a little hesitant to pull the trigger while they wait for a little bit more clarity on the state of the Alberta economy generally speaking. So there's interest but from the industrial players, the 3PL groups, the groups who are servicing the oil and gas fields, we're seeing a little bit of hesitation in terms of actually pulling the trigger so far. Okay. And just finally on the Steels DC that is on Canadian Tire's balance sheet, any update there? Any progress since last quarter? Sam, it's Ken. There's no progress really to report on that. We continue to have discussions with Community Entire around potential build form on the property and how it might be used, but nothing concrete to report at this moment. But they've confirmed that they do not need that site for their own purposes anymore? At the moment, yes. Thank you. I'll turn it back. Thank you. The next question is from Jenny Ma from BMO Capital Markets. Please go ahead. Your line is open. Thanks. Good afternoon. Hi, Jenny. Hi. This question is probably for Leslie. I just wanted to make sure that the contribution from acquisitions and developments in 2019 that you guys break out in the MD and A ties to the $81,000,000 of total investments for Q1? Sorry, the $81,000,000 sorry. So it's a $360,000 on Page 36. I just want to make sure that was just from the bucket that's being described in Page 10, the $81,000,000 the acquisitions and the redevelopments that were done during the quarter. Catching up with you, Jenny. Hang on. Thanks. So, Jenny, I'm just looking through the list of properties. Yes, all those ones are either new acquisitions or items that have been moved from property development into investment property in the current quarter and they should be in those 2018, 2019 sort of net offering but not same store. Right, right. So I guess based on that number, the $360,000 most of these would have closed I guess towards the end of the quarter. So there's probably a bit more contribution coming from that bucket into Q2? Yes, you're correct. Some of those stores were truly the last couple of days of March. Okay, got you. With regards to sorry, one second, I'll just double check here. Going back to the question about the secondary markets, so your peers have been selling quite a bit. Have you guys internally sort of gone through your portfolio to see if there are some properties that you might consider to be non core, so to speak, or have maxed out their growth potential and you would potentially look at selling? Or do you view these sort of because they're Canadian Tire anchored and occupied that they are all core to the CTVIT portfolio? Jenny, it's Ken. I'll never say never, but we currently have no plans to divest certainly of Canadian Tire anchored properties in dairy markets. There are circumstances where we might see Canadian Tire move out of an existing store into a newly built store. At the time of the IPO, we had identified a number of stores that we didn't think would meet Canadian Tire's long term requirements. And we did not vent those into the REIT at that time. This new store the old store in Grand Prairie was an example. So Canadian Tire still owns that. But we now own the new store. So it's possible that we might sell a property that Canadian Tire has moved out of because we don't want to reinvest in that building in that specific market. But it's really a case by case basis as opposed to some sort of overarching strategy that we want to recycle capital out of secondary markets. Okay. That makes sense. With regards to hold on one second, I'm just going to see here. You know what, I will have to circle back with you on that. I'll get back to you on it. I just lost my train of thought there. Okay. Great. Thanks. Thank you. Thank you. The next question is from Pammi Bir from Scotia Capital. Please go ahead. Thanks. Good afternoon. Just not to beat a dead horse here, but coming back to 11 Dufferin. Is there a possibility that Canadian Tire might have some interest in permanently occupying that space? Or can you convince them? Well, we can certainly try. It's Kevin speaking, Pammi. As of right now, there's no indication they require the space beyond Q2. Obviously, should that change, we can update you at that time. I guess maybe just sticking with that, are there any challenges or maybe unique features that make this property maybe a bit more difficult to lease at all? No, no, not specifically. I mean the depth of the building is good. It's 28 feet clear high, got base, got some additional land next to it. It's near the CN Rail Yards and highway infrastructure. So it's actually highly desirable. I think it's more the state of the Calgary industrial market. There's supply a new supply coming on stream over the next few quarters. Probably a different type of asset, newer inventory, higher rent. So we actually like our positioning. It's just, waiting for the right tenant. Right. That was actually one of my questions I guess on the new supply side. But maybe just switching gears, if you look at the balance of the year from an investment standpoint, how much do you expect to spend on developments for say again through 2019 versus a transfer to income producing? Pammi, it's Ken. Well, we've got pretty good visibility obviously to as laid out in the MD and A as to when we expect some of the properties in the development pipeline to transfer to income producing. So we're pretty clear on that. With respect to we continue to work with Canadian Tire as they develop their pipeline of new projects. Above and beyond that is if there's an acquisition that we'd like to move on as we said before that tends to be a little bit more opportunistic. We've been frankly I think relatively patient with regard to what's been on the market and what we're prepared to bid on. Okay. Just one last one. If you look at what Canadian Tire has left in terms of their retained portfolio, you gave us some color with respect to back of the IPO and some of the assets that they kept. Do you have a rough sense of how much of that could be ready to be vended into the REIT over the next 12 months? It's Ken. No. We've invested or are moving a few of the projects a couple of stores in this year so far. I mean frankly we kind of view the inventory of properties that Canadian Tire still owns frankly as inventory that will tap into that as a source of growth depending on other things that we see happening. Okay. Thanks very much. Okay. Thank you. Thank you. The next question is from Tal Woolley from National Bank Financial. Please go ahead. Hi, good afternoon. Hi. I just wanted to ask to go back to the secondary market question. Do you have in your conversations with Tire, have you had heard any concerns about some of those secondary market locations not being able to sort of support the 1.5% rent increases over the long term? Tal, it's Ken. 2 things. 1 is we average 1.5% rent increases across the portfolio, but we actually distribute the over the portfolio in different ways. So not every store is 1.5% every year. There are some that are lower. And at the time of the IPO, we kind of were reflecting what we thought of as the potential growth rates within that market. What I can tell you is, since the IPO, frankly, I think Canadian Tire has done a great job competing in the retail market. And if you look at same store sales growth has been quite robust for the past 5 years or so. So we're quite comfortable with really where Canadian Tire has been. If anything, if there is a pressure, it's that Canadian Tire is outgrowing the stores. And as I mentioned in my script, I mean, we've expanded 40 stores so far. And Canadian Tire kind of gets to the point where when they see sort of store productivity kind of bumping up into certain levels, then they'll look to expand the stores. And I can tell you that those store expansions and that pressure has come across as much in secondary markets as anywhere. So we don't see any concerns. Okay. That's great. Thank you very much. Okay. Thanks, Thao. Thank you. There are no further questions at this time. So 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 expect our Q2 results will be released the last week of July. We look forward to speaking with you then.