Earnings Call: Q1 2018

May 8, 2018

Earnings release

Good afternoon. My name is Greta, and I will be your conference operator today. At this time, I would like to welcome everyone to Citigroup's First Quarter Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. The speakers on the call today are Ken Silver, Chief Executive Officer of Citi REIT Louis Forbes, 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 CTREIT's public filings for a discussion of these risk factors, which are included in their 2017 MD and A and AIF, which can be found on Citi REIT's website and on SEDAR. I would now like to turn the meeting over to Mr. Ken Silver, Chief Executive Officer of CTE REIT. Ken? Thank you, operator, and good afternoon, everyone. We're very pleased to welcome you to CTE REIT's Q1 2018 investor conference call and to share with you the results of another strong quarter. We continue to execute on the strategies that complement the core portfolio of Canadian Tire Store Properties, delivering attractive and reliable results quarter in and quarter out. The highlights of the quarter include the completion of the acquisition of a portfolio of properties from RioCan that we announced late last year as well as a new round of investments related to Canadian Tire that will be completed this year and next. Our relationship with Canadian Tire and our ability to work with the Canadian Tire team as they plan their store networks provides not just a source of growth, but great visibility and predictability to that growth. The transition from a Sears Canada tenancy to a CTC tenancy in our major distribution center property in Calgary is underway and is reflected in our reported results. In acquiring this year's property in 2016, we understood the possibility of getting the building back and knew that if we did, we would go through a transition period, that period now being this year. We are delighted to have this asset and the surrounding industrial properties in our portfolio, and events have unfolded as we had hoped. Another highlight of the quarter was the $200,000,000 unsecured debt offering we completed in January. In keeping with our conservative financial management, we termed out our existing shorter term floating rate debt for a fixed rate offering with a term of nearly 10 years. The offering was extremely well received, significantly oversubscribed, and we are very pleased with the coupon achieved. We continue to maintain a weighted average term on our debt of 10 years, nearly double the average of our peer group and reflective of our conservative approach to managing our risk profile. And last but not least, beginning with our January distribution, we implemented a 4% increase, which now equates to a distribution of $0.7208 on an annual basis. At this point, I will now turn the call over to Kevin Salzberg, our Senior Vice President of Real Estate, to discuss our leasing investment and development activities. Louis Forbes, our Chief Financial Officer, will then briefly 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 announce 4 new investments this quarter for an aggregate total investment of $35,000,000 These new projects are comprised of 2 vend ins, 1 intensification and 1 new development where we will be building a 65,000 square foot Canadian Tire store on a piece of land that we acquired from a third party located in Grand Falls Windsor, Newfoundland. These investments, when completed, will result in an incremental 191,000 square feet of gross leasable area being added to our portfolio and are expected to earn an average going in cap rate of 6.68 percent. As Ken mentioned, we have also completed the acquisition of the 2 remaining RioCan properties, which are located in Collingwood and St. Catharines, Ontario. Both are Canadian Tire anchor and these investments have increased our GLA by an additional 351,000 square feet. As previously disclosed, the investment made by the REIT in these two assets was approximately $66,000,000 In the first quarter, we also completed the redevelopment of an existing Canadian tire gas bar in LaSalle, Quebec. As outlined in our earnings release, CTE REIT also made a change to the development plan and timing for the Sherwood Park North property in Alberta. The initial plan was to build a 93,000 square foot Canadian Tire and a freestanding 20,000 square foot Mark store. The revised plan for this site is to now develop a new 120,000 square foot Canadian Tire store only, with construction expected to be completed in Q4 2019. At the end of the Q1, CTE REIT had 13 properties under development representing a total committed gross leasable area of 747,500 square feet and a total committed investment of $150,800,000 upon completion. As at March 31, 2018, on a committed basis, our portfolio is 98.7% occupied. Canadian Tire has taken occupancy of the former Sears distribution center in Calgary and the leasing efforts for the smaller property at 11 Dufferin Place Southeast that CTC formerly occupied are underway. Pleased with the initial response from the leasing market and continue to assess options for this property as well as the adjacent lands that we acquired at the end of last year. Beyond what was completed during and subsequent to Q1, we continue to make progress as expected on the balance of our development projects as detailed in our latest MD and A. With that, I will turn it over to Louis for a review of our financial results. Thanks, Kevin. In Q1 2018, we reported FFO per unit of $0.277 as compared to $0.279 per unit in Q1 of 2017, a decrease of 0.7%. AFFO per unit was $0.233 as compared to $0.227 in the comparable period, representing a 2.6% growth rate. Net operating income was $84,400,000 increasing 6.6% over the $79,200,000 of NOI reported for Q1 2017. This growth was primarily driven by acquisitions, the completion of income producing properties which were under development in the prior year and contractual annual rent escalations. The same store growth of 1.5% and same property growth of 1.7% were driven by average annual rent escalations of 1.5% contained in the Canadian Tire Store and CTC Distribution Center leases, which are generally effective January 1st, the recovery of capital expenditures and the related interest earned. There were 2 unusual components of same store growth this quarter. Our reported results reflect the loss of rent effective mid January from the vacancy at the former Sears DC at 25 Dufferin Place, Calgary. This event hurt cash NOI in Q1 of 2018 by approximately $1,400,000 The other adjustment relates to prior period rent charges at 2 of our properties and amounts to approximately $700,000 This partially offsets the impact of Sears departure. If we were to adjust the reported same store NOI growth for these two components, then same store NOI growth would have been 2.3%. Of less importance, but to offer a full explanation, the REIT has provided approximately $450,000 in Q1 for the write off of previously recorded straight line rent from Sears. This provision affects revenue, net income and FFO, but has had no impact reported AFFO or NOI metrics as their calculation excludes straight line rent. While we are talking about Sears, there are a couple of further points we would like to make. Firstly, we expect NOI in the Q2 of this year will be negatively impacted by another approximately $750,000 for the transition from Sears to CTC. Thereafter, we expect a smaller drag on our results going forward until such time as we lease up the vacant space at 11 Dufferin Place Southeast. G and A expenses as a percentage of property revenue improved to 2.8%, 60 bps lower versus Q1 20 17, which was at 3.4%. G and A expenses decreased 14.4% versus Q1 2017, primarily due to the impact of fair value adjustments on personnel and board compensation expenses. Interest expense increased by $2,000,000 or 8.3 percent compared to Q1 of the prior year. This was principally the result of increased borrowings, but also because of greater use in 2018 of more expensive longer term debt. In February, CTE issued $200,000,000 in debentures having an original term of 9.8 years and a fixed rate coupon of 3.87%. This had the effect of replacing short term and expensive debt with longer term fixed rate debt. While this is impacting our earnings growth in the short term, the issuance ultimately leads to improved liquidity and a stronger balance sheet in the long term. This most recent issuance illustrates a couple of points about our debt strategy. The chosen term, 9.8 years, is consistent with our sector leading weighted average term to maturity of 10 years. The coupon for the chosen term was, as typical, more expensive than a shorter term debenture would have been, but less so than some other occasions in the market, influencing our decision to go for the longer tenor. Additionally, the longer term chosen provides flexibility for the REIT with respect to future borrowings and allows us to consider a broader range of potential terms in response to market conditions at that future time. The REIT recorded a fair value adjustment of $13,300,000 for the Q1 of 2018. Valuation metrics used were virtually unchanged from those used in our December 2017 reporting. With respect to the balance sheet, we continue to maintain a strong financial position. At March 31, the REIT indebtedness ratio remained at 46 0.7%, unchanged from last quarter. We also have approximately $265,000,000 available on our credit facility as well as over $12,000,000 of cash, which puts our balance sheet in a strong and liquid position. Debt as compared to earnings before interest, taxes and fair value adjustments was 7.58x, slightly lower than the 7.62x reported in Q4. Also, as at March 31, 332 of the REIT's assets were not encumbered, representing approximately $5,400,000,000 or 98 percent of our assets. As at March 31, only 2.7 percent of the REIT's debt bears interest at floating rates, reflecting the recent fixed rate debt issuance. In terms of interest coverage, the ratio was at 3.31x in the 1st quarter, which was slightly lower compared to the prior year value of 3.43. The decrease, which we do not view as material, is mostly the result of interest and financing charges increasing at a rate larger than that of income before interest taxes and fair value adjustments. Our AFFO payout ratio this quarter was 78%, slightly higher than the 77% ratio in Q1 of 2017. The change in ratio reflects a more moderated growth in our AFFO per unit. Canadian Tire represents 92.6 percent of our annualized base minimum rent on a committed basis, and they occupy 94.5 percent of CTE REIT's GLA. All of these metrics are largely unchanged from a year ago. I'd also like to take a minute to speak to the trend in our book value per unit. At March 31, 2018, the book value per unit was $13.54 representing 1.1% growth over the book value of $13.39 reported at the end of the Q4 2017. The following are contributing factors to this increase: a modestly higher value for the income producing properties due to ongoing growth in cash flow resulting from the annual rent increases and retained adjusted funds from operations. On a trailing basis, combining distributions and book value per unit growth, C. T. Reid has, since IPO, consistently delivered a total annual return excess of 10%. With that, I'll turn it back to Ken. Thanks, Louis. As I said at the opening, we're very pleased with the quarter. The only exception to that would be our unit price. On our last conference call, I pointed out that we were trading at a discount to NAV for the first time in our history, and this condition has not yet reversed. Given recent M and A activity in the REIT sector, we believe that our relative positioning has only gotten stronger, that a reliable growth, conservative balance sheet, investment grade credit rating and potential for distribution growth provide today more than ever a unique set of positive attributes for our investors. We are confident in our ability to deliver and look forward to continuing to add to our track record. And now, operator, I'll turn the call back to you for any questions from our listeners. Thank you. The first question is from Sam Damiani of TD Securities. Please proceed. Thank you and good afternoon. Good afternoon, Dave. First off, just on the Dufferin district. Can you provide a little bit of color on what you're sort of seeing or maybe Kevin did, but wonder if you could provide a little more sort of guidance as to when we should expect that backfill to be leased up? And the 5,500 Dufferin Boulevard property, has that been leased? So I'll start with the 5,500 sorry, Sam, it's Kevin. The 5,500 Dufferin Boulevard property was leased, effective the date we basically got the building back. The transportation company that occupied With respect to 11 Dufferin, Canadian Tire With respect to 11 Dufferin, Canadian Tire remains in the building until mid August. So we really just started our leasing efforts. And so far, the interest has been good. Well, I can't say exactly when the space will be occupied, we are positive about the prospects. We've noted there's not a lot of large format 2017. So hopefully all that translates into a positive outcome for our vacancy. Okay. So just to follow-up there. Do you have a pending net vacancy to occur in August then when, I guess, CPC pulls out of the 11 different asset? Correct. We're reporting occupancy on a committed basis, so it's reflected in the numbers currently. But yes, we will have an actual vacancy once they Okay. And so maybe over to Louis, you mentioned there would be a net negative or at least a negative adjustment to Q2 NOI of $750,000 And so I guess there would be a further negative adjustment when CTC leaves the other Dufferin Place property? Well, yes and no. So let me be clear. You said further negative. CTC started paying rent at the beginning of May for the larger Sears DC space that they occupied. And at that time, their responsibility for base rent at 11 Dufferin fell away. They're responsible for the operating expenses in both buildings until August. And then in at the beginning of August, their responsibilities for the operating expenses and their possession of 11 Dufferin Cease at that time. So when I mentioned $750,000,000 as the Q2 hit, that included the large Sears space as vacant and nobody paying rent for the month of April. And then the loss of the base rent on the smaller building, 11 Dufferin, for May June. And that's all together in the $750,000,000 I think the run rate loss at 11 Dufferin on a monthly basis will be about $120,000,000 $130,000 a month once it's vacant. Okay. Okay. All right. That's clear. So a lot of detail, but We got it. Okay. I'll turn it back for now. Thank you. Thank you. Thank you. Thank you. The next question is from Jenny Ma of BMO Capital Markets. Please proceed. Thanks. Good afternoon. Hi, Jenny. Hi. My questions on Calgary, I think, have more or less been answered. So the small piece, the 5,500 Dufferin, there was no interruption in rent. Is that correct? If the new tenant leased it up as of February? That's correct. The only thing to note is the new tenant is paying a higher rent than the old tenant relative to that building. And they have also taken some additional lands that will come on stream once created, probably mid to end of July. And the additional rent that they're paying related to those additional lands, I think, is incorporated in Louie's overall run rate number going forward. Okay. Okay. Got you. And then just a clarification question, Louis. On the $700,000 of the adjustments to the prior period rent, that's a one time expense, correct? Sorry, a onetime income? Yes, that's correct. Okay. So then after we adjust for the DC here, we should have a pretty good run rate for Q2, Q3 going forward, nothing else one time in nature? Correct. Okay, great. That was all for me. Thank you very much. Thank you. Thank you. The next question is from Pammi Bir of Scotia Capital. Just maybe one last one with respect to the Sherwood Park property. Can you just elaborate there on what motivated the change and why the extended time line for the redevelopment versus the prior expectation? Sure. Pammi, it's Kevin. Originally, as I mentioned, Canadian Tire planned to do a 90 3,000 square foot store. In reviewing the market, generally, they decided a larger store was warranted. So I think that decision reflects their confidence in the market. The change in timing relates to municipal approvals that they go back and get for the amended store size. So they had sought the approvals, received them, then had to go back in with a site plan amendment, So hence the delay. Got it. Thanks very much. Thank you. Thank you. The next question is from Sumayya Hussain of CIBC. Please proceed. Thanks. Just on the increase in the normalized CapEx reserve this quarter, was this done to reflect some of the more recent acquisition? Or did you guys kind of look at the overall mix of the portfolio and just make the decision more so from that perspective? Sumay, it's Louie speaking. The reserve increase, I think averaged about $0.03 a square foot of an increase. It does reflect in part that the nature of the portfolio has changed a bit, although that's small within the overall portfolio. It also acknowledges a little bit of cost inflation in terms of getting things done. Like it costs more to pay this year than it did last year. Okay. And just on the investments announced in the quarter, just roughly speaking, how would the cap rates on the vendors compared to the Grand Falls acquisition? And can you also remind us roughly the yields you guys are targeting on intensifications? So your first question was what was the yield on the 2 Vendons relative to the new development? Yes. Did I get that right? I think they were pretty comparable in terms of I'd have to go back and check the details. We can circle back with you on that, but I think they're mid to high 6s, generally speaking, probably more in the mid 6s ballpark. Thank you. The next question is from Tal Woolley of National Bank Financial. Please proceed. Hi, good afternoon. I just wanted to ask a question about some of your comments from the AGM this morning, Ken. You had made mixed use development and how you were sort of interested to see how some of your peers proved out that strategy going forward. And I guess implicit sort of in that statement maybe or maybe not is that you sort of have a bit of a different view about what that model will bear in terms of returns over time. Is there any particular that you're sort of waiting to see as you go forward as you see some of these projects start to come to fruition? Tal, thanks for the question. I think there's two aspects to it. One is, firstly, we're in an extremely fortunate position in that. We have such solid growth and visibility to the growth that we have that we can continue to pursue what I would describe as a low risk strategy that we think should be attractive that we think should be attractive to investors going forward. So that's sort of one component of how we view what I would describe and I think most people would view as higher risk development activities. In view of our view on those activities is there's no question that like others, we have intensification opportunities in the portfolio. But we are interested in seeing how exactly these unfold from the perspectives of the kind of achieved returns that you can get. And so we have the luxury really of waiting to see, as I had described it this morning, as seeing the business case proved out. Okay. And then Louie, sorry, you might have touched on this in an earlier answer, but just to make sure I've got it through my fixed call. The straight line rent number, the adjustment this year jumped down. Is that because of the reversal of the prior period booked on the DC? Tal, no, that's a perceptive question. It would drop for two reasons. It would generally drop the run rate would drop in Q1 of every year. And when I say every year, at IPO, we had a weighted average lease term of about 16 years, not quite 16 years, which meant that the straight line rent dynamic on the 255 buildings we started with would flip at year 8. So the street line rent adjustment should come down about $3,500,000 every year for 8 years. And then it turns and becomes a positive adjustment and grows in the opposite sense. So that is affecting Q1. But also the Sears comment I made about straight line, which was about $450,000 I said, that also affected Q1. So and we don't expect that to repeat in Q2. So the straight line rent adjustment in Q2 should be bigger than the Q1 adjustment by $450,000 for that reason. Beautiful. Thanks, Lee. Thank you. You. The next question is from Sam Damiani of TD Securities. Please proceed. Thank you. The other question I wanted to follow-up on, Ken, was just on with the 10 year bond yield at its highest in about 4 years. How are you looking at cap rates and yields on transactions with CTC in the light of the relatively high industry we're in today and the consensus is we're going to further be in over the next couple of years? Sam, we review each transaction. We do at Canadian Tire. We do appraisals. We benchmark against other transactions that we've done. We look at what's going on in the marketplace. So far, we haven't seen really a change in the pricing. Nothing material really to report to you, but it's just something that we would continue to monitor on an ongoing basis. Okay. Thank you. Thanks. Thank you. As there are no further questions at this time, I will turn the call over to Ken Silver, Chief Executive Officer, for any closing remarks. Thank you, operator, and thank you all for joining us today. We expect our 2nd quarter results will be released the 1st week of August, and we look forward to speaking with you then. Thanks. Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation. Please disconnect your lines at this time. We thank you for your participation.