Earnings Call: Q3 2019

Nov 5, 2019

Earnings release

Good morning. My name is Melanie, and I will be your conference operator today. At this time, I would like to welcome everyone to C. T. REIT's Third 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 C. T. REIT Leslie Gibson, Chief Financial Officer of C. T. REIT and Kevin Salzberg, Chief Operating Officer of C. T. 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 C. T. REIT's public filings for a discussion of these risk factors, which are included in their 2018 MD and A and AIF, can be found on CTREIT's website and on SEDAR. I will now turn the call over to Ken Silver, Chief Executive Officer of CTREIT. Ken? Thank you, operator, and good morning, everyone. We're very pleased to welcome you to CTE REIT's Q3 2019 investor conference call. As is typical with CTE REIT, our 3rd quarter results reflect the predictable growth arising out of our large portfolio of long term triple net CTC leases. In the quarter, we also realized an additional benefit from our successful investment in the former Sears Canada industrial facility in Calgary, this one due to the assignment of a claim arising from Sears CCAA filing. We look forward to further upside in Calgary once our vacant industrial property at 11 Dufferin is leased up. Another highlight of the quarter was the completion of a joint treasury and secondary equity offering with CTC. With this issuance, we've accomplished our goal of significantly increasing our public float and are advised that with this milestone, we are likely to be included in a number of indices, including the TSX Composite, CAFD REIT, Dividend Aristocrat and high yield indices when they are next rebalanced. And speaking of dividends, we were delighted to announce our 6th annual distribution increase in the 6 years since going public, a 4% increase to take effect in January 2020. Over our history, we have delivered one of the strongest track records in the sector of AFFO and NAV per unit growth as well as distribution growth, while operating with one of the most conservative and secure balance sheets. Our disciplined and focused strategy is one we believe will continue to reward investors. As we near the end of 2019, one of the other highlights we can look back on is the progress we've made on Canada Square redevelopment at Yonge and Eglinton in Toronto. As previously indicated, we are excited to be increasing our ownership interest in this exceptional development opportunity to 50%, which is expected to close within the next few months. We look forward to sharing more information about the redevelopment in the coming year. I'm now going to turn the call over to Kevin Salzberg, our newly appointed Chief Operating Officer, to provide an update on our investing activities and operations. Kevin joined CTE REIT about 3.5 years ago and has contributed significantly to the growth of the REIT and the quality of our acquisition, development, leasing and asset management programs. Following Kevin will be Leslie Gibson, our Chief Financial Officer, who has recently celebrated her 1 year anniversary with The REIT to discuss the financial aspects of the quarter. With Leslie and Kevin, together with Kim Graham, Clint Elenko and David Goldstein, I'm delighted with the evolution of the senior management team at CTE and the depth of talent we have in the organization. Kevin? Thanks, Ken, and good morning. As outlined in yesterday's release, we are pleased to announce 7 new investments this quarter totaling $66,000,000 This includes a new third party acquisition consisting of a sale leaseback transaction to buy 11 freestanding retail bank branch locations that was completed subsequent to the quarter end. This portfolio highlights our focus on triple net leased properties and is a great complement to our existing asset base. It is entirely leased to the Bank of Montreal, an investment grade tenant on a long term basis and consists of a geographically diverse set of single tenant properties situated on great corners in very attractive urban and secondary markets. All leases contain contractual rent escalations every 5 years, providing for embedded organic growth. We are also pleased to announce additional investments related to our pipeline of Canadian Tire opportunities, consisting of 1 Bendin and 5 Canadian Tire store expansions, one of which required us to acquire some additional land adjacent to an existing property that we own. These investments reflect a continued focus on our core strategy and continuing Tire's confidence in its business and ongoing investment in its store network based on a proven track record of growing sales and improving store level productivity. In total, these investments, when completed, are expected to earn a weighted average cap rate of 6.5% and will result in an incremental 281,000 square feet of gross leasable area being added to the portfolio. Additionally, we invested approximately $4,000,000 in previously announced projects that were completed in the Q3. These projects included the intensification of a Canadian Tire store in Brampton, Ontario, the development of a Canadian Tire Gas Plus Gas Bar in Innisfil, Ontario and the development of a Canadian Tire Gas Plus Gas Bar and Car Wash in Hamilton, Ontario. At the end of the Q3, CTE REIT had 29 properties under development. These properties represent a total committed investment of approximately $251,000,000 upon completion and a total gross leasable area of approximately 1,300,000 square feet, nearly 95% of which has been pre leased. Excluding the properties under development, our portfolio remains in a strong position with 98.8 percent occupancy as of the end of the 3rd quarter, remaining consistent with Q3 of the prior year as well as the prior quarter. With that, I will turn it over to Leslie for a review of our financial results. Thanks, Kevin, and good morning, everyone. Our strong Q3 results yet again continue to demonstrate the underlying quality of our portfolio. In Q3 2019, we reported AFFO per unit diluted of $0.261 an increase of 8.3% compared to $0.241 per unit in Q3 of 2018. Additionally, FFO per unit diluted increased by 4.8% to $0.303 compared to $0.289 in Q3 of 2018. Reported net operating income was $93,900,000 for the quarter, an increase of 7% compared to the same period in the prior year. The primary drivers of NOI growth include the acquisition of income producing properties and properties under development completed in 2019 2018. Same store NOI increased by $3,800,000 or 4.4 percent and same property NOI increased by $4,400,000 or 5.1 percent compared to Q3 2018 and were driven by several factors, including contractual rent annual rent escalations of 1.5% on average contained within the Canadian Tire store leases, contributing approximately $1,700,000 to NOI growth. And the recovery of capital expenditures and interest earned on the unrecovered balance and intensifications completed in 2019 2018, contributing approximately $1,200,000 In addition, as Ken mentioned, there was an additional component to same store growth this quarter related to the former Sears tenancy in Calgary, Alberta. The impact of the tenancy changes at 11 Dufferin Place Southeast and 25 Dufferin Place Southeast Calgary and the amount received from the assignment of the REIT's interest in a claim against Sears Canada under the CCAA, together with increased NOI by $1,200,000 If we were to adjust the reported same store NOI growth for this $1,200,000 then same store NOI growth would have been 3.0%. G and A expenses for the quarter amount to 2.4% of property revenue, which is consistent with Q3 2018. Excluding the fair market value changes, G and A expenses as a percentage of property revenue improved to 2.2% for the quarter. This is due to both the successful implementation of the ERP system and capabilities that have started to demonstrate a positive impact related to the general and administrative expenses and the property operating expenses, as well as an increase in revenues driving same store NOI growth this quarter. The fair value gain on investment properties as of Q3 2019 was $12,900,000 a decrease of $3,800,000 compared to the same period in the prior year. The decrease is primarily due to higher increases in property values across the portfolio in the prior year. Turning to the balance sheet briefly, we continue to maintain a strong and liquid financial position. We have approximately $295,000,000 available on our credit facility as well as over $47,000,000 of cash as a result of the recent equity offering, which we anticipate going to use the balance of the 4th quarter. As Ken also mentioned earlier in September, we completed a joint equity offering for an aggregate 16,800,000 units comprised of the issuance of 6,300,000 units from treasury for net proceeds of 86,000,000 dollars and the sale of 10,500,000 units by Canadian Tire Corporation. The net proceeds of the treasury offering were used to pay down amounts owing on our credit facility, to fund our investment program and for general working capital and corporate purposes. We are pleased with the positive impact the equity offering has had on our float as well as 12 trading volumes, both key ingredients for an improved liquidity for all unitholders. The interest coverage ratio increased to 3.45x this quarter compared to 3.36x in the same period in 2018. This is primarily due to the growth in the EBITDA fair value exceeding the growth in interest and other financing charges, despite the interest related to the lease liabilities being included in interest expense in 2019. As of September 30, CTE REIT's indebtedness ratio was 42.8%, a decrease compared to the 45.1% as of December 31, 2018, and 44% as of June 30, 2019. The decrease in the ratio is primarily due to the equity offering completed during the quarter as well as our 2019 acquisitions, intensifications and development activities, the fair value adjustments made to our investment property portfolio and a decrease in total indebtedness. Indebtedness to EBITDAFV ratio was 6.96x as of the quarter end, lower than the 7.34x reported in Q4 2018 and the 7.16 times reported at Q2 twenty nineteen, primarily related to the EBITDA growth exceeding the growth in CT's total debt. Our AFFO payout ratio this quarter decreased compared to Q3 2018 to 72%, though our Q3 year to date AFFO payout ratio 75% remains in line with 2018. I also want to briefly remark on the trends in our book value per unit. As of September 30, 2019, the book value per unit was $14.46 representing a 3.2% growth over the book value of $14.01 reported at the end of Q4 2018. The increase is due to net income exceeding distributions. And with that, I'll turn it back to Ken. Thank you, Leslie. As we near the end of 2019, CTE REIT's core attributes have never been clearer. Our ability to deliver both attractive growth and low risk anchored in a strong balance sheet and the highest investment grade credit rating in the sector have led again to the announcement of another distribution increase. The clarity and simplicity of our strategy and more importantly, the results are there for investors to see. And now, operator, I'll turn the call back to you for any questions from our listeners. Thank you. The first question is from Himanshu Gupta of Scotiabank. Please go ahead. Thank you and good morning. Good morning. Good morning. On the acquisitions, the BMO Bank branch's portfolio that you bought, and I know you bought CIBC Bank branches earlier as well. Is that a segment you're actively looking at? And what was the cap rate on this portfolio? And what are the rent escalators? Hi, it's Kevin speaking. We can't disclose the specifics of the transaction. To your first question, I would say, yes, this is a segment we're continuing to be interested in. We bought the CIBC portfolio that was similar in nature in 2017. These are nice tuck in acquisitions for us and obviously complements the existing portfolio and are very closely aligned with the existing type of assets that we currently own. But we'll do it selectively and opportunistically. So just stay tuned for, I guess, the amount of investment we're pursuing in this vein. The rent escalations are every 5 years. In terms of the cap rate, I can say it's a mid-six percent cap, but I can't really give details beyond that. Sure. Thanks, Kevin. And by the way, congratulations on your promotion to Chief Operating Officer. And just sticking to acquisitions, Canadian Tire Corporation has recently completed acquisition of Party City in Canada. Are there any plans to vend in those assets? I mean, will you have any exposure to Party City down the line? So there are no owned Party City assets. So there's no specific vend ins that might be opportunities for the REIT. We're working closely with Canadian Tire as they develop their plans for any new Party City locations and to the extent there are opportunities within the REIT portfolio that match their strategy, obviously, we will work closely with them on that. Sure. And just switching gears on the one time, that NOI adjustment of $1,200,000 is that the final amount? I assume most of the amount is from Sears or do you expect any more settlement down the road? And the second thing would be regarding the vacancy at 11 Dufferin, any update there? Sure, Himanshu, it's Leslie. I'll take the first part of that question. The $1,200,000 is comprised of a couple of things we've noted in the MD and A. It's some of the tenancy changes at our two different locations in Calgary and our industrial portfolio, as well as the amount we received from selling our claim under the CCAA and that is really the last piece. That's a one time transaction for the selling of our CCA claim. On the leasing progress, I can say we're in advanced stages with a couple of groups that would take portions of the building. I'm optimistic that we'll be able to get something done there, but we've been at this stage before with others. And obviously, in the current environment today in Alberta, people are somewhat reticent to make investment decisions. So stay tuned, but hopefully we'll have something for you in the next quarter or 2. Sure. And probably last question from me on valuation in terms of cap rates, especially in secondary markets. So what are you seeing today versus, say, 18 months back? And how are your Canadian tireless stores performing in these secondary markets, say, compared to 2 years back or 18 months back? I mean, I assume you monitor these store level performance. On the cap rate side of things, we've talked a little in the past about the liquidity and the level of interest of the type of assets we own, the single tenant properties in a certain price range, to be honest, they've been flat in all markets, in my opinion. There's still a lot of interest, a lot of buyers out there for these well tenanted long term lead type product. And I think the BMO deal is kind of reflective of that. There was a lot of interest and we're happy with obviously the cap rate, but I think it does support kind of our general valuations as it relates to the Canadian Tire portion of our portfolio. In terms of Canadian Tire's sales and productivity in those markets, I think it continues to be robust. They're doing well. Obviously, they can speak to their trends better than we can, but all things are positive on that end. Sure. And maybe I'll just squeeze in one last question on the G and So how should we think about modeling them next year? So how should we think about modeling them next year? Himanshu, it's Leslie again. You'll start to notice in the current quarter Q3, since our system went live back in May, we're now starting to see in Q3, I think, the benefits of some of that internalization. So the G and A run rates that you see in Q3 are now more reflective of what we think will occur in the future. The following question is from Pammi Bir of RBC Capital Markets. Please go ahead. Thanks and good morning. Just coming back to the bank branches, again, this is the 2nd transaction you've done for branches. But should we interpret that as you're looking at doing perhaps more triple net lease transactions even outside of the bank branches, whether it's other retail or is it at this stage really just the Canadian Tire portfolio and perhaps some branches? Pammi, it's Kevin. I guess I would say similar to my previous comment, we'll be opportunistic about the opportunities. We would consider branching out beyond CTC, beyond banks. Retail is our preferred asset class, but that doesn't mean we wouldn't look at others as well. Obviously, 15% of our portfolio roughly is industrial. So we like that, but those are competitive assets today. So I think it's based on the opportunities that present themselves and whether or not it fits in terms of our asset criteria and obviously trying to find accretive opportunities. Thanks. And Kevin, congratulations as well. Thank you. Just on maybe on Canada Square, any update on you mentioned transaction maybe in the next few months. Can you be a little more specific and perhaps the potential range of the investment to increase your stake? Pammi, it's Ken. I think in our last call, we had indicated that the purchase price was going to be determined as part of a process as laid out in the co owner's agreement. And that is proceeding, perhaps a little bit slow more slowly than we had expected at the last quarter, but it is unfolding as per the co owners agreement. So I would expect that we'll see it close in the next few months as we mentioned in our comments. And at this point, obviously, I can't comment on valuation or the purchase price. The following question is from Jenny Ma of BMO Capital Markets. Please go ahead. Thanks. Good morning, everyone. Good morning. This question is probably for Leslie, but I see in the financial statements that there was $1,800,000 of other income booked versus very minimal or almost none in most other quarters. Is that all related to Sears? No, Jenny. The Sears as well as some of the other changes in tenancy only in total amounted to 1.2. The portion from Sears was the larger portion of the 1.2 of those 2 items. But there's just some other sort of, I would describe as sundry revenues and bits and pieces from some of our investments that are showing in that $1,800,000 you see in the other income line this quarter. Okay. So is there anything in that bucket that might be of a recurring nature or is it mostly one time? There's some other bits that are Go ahead. There are some other bits that are recurring, but I'd say they're quite small, Jenny. Okay. That's fair. With regards to the BMO portfolio, are you able to comment on the weighted average lease term? Yes. I believe off the top of my head, it's about 12 years. 12 years. And are there extensions on it? Yes. Okay, great. Okay. And then most of my questions have been answered. My last one is related to some of the Class C unit expiries coming up in May of 2020. Have those discussions started with CTC? We have regular conversation with CTC about what their plans are, and we'll continue between now and then, but nothing has been decided at sort of this early juncture as of yet. The following question is from Sam Damiani of TD Securities. Please go ahead. Thanks. Good morning, everyone. Maybe Ken, just to start off, the leverage of the REIT has come down consistently over the 6 years of its history. What is the goal over the next couple of years? I know it will tick up once the Canada Square acquisition closes a little bit, but are you targeting low 40s or even 40% or 40% or lower going forward? Good morning, Sam. I'd say we're certainly comfortable with the leverage that we're operating at today. You're absolutely right. It has come down over the years. We think that that is has been a prudent path to be pursuing. And I wouldn't say that we would be looking at material differences in our leverage in either direction at this point. From where it is in Q3? Yes. Okay. And over to the triple net sort of strategy, talked about that a little bit already. But I wonder, would gas stations not operated by Canadian Tire, would that fit the bill if that opportunity were up to a rest? Sam, it's Ken again. And I'd say theoretically, yes. I mean, we would be looking across, as Kevin mentioned earlier, different asset classes, different kinds of properties. I think what we would be looking for is you find with the net lease REITs in the U. S. That they invested in quite often a variety of asset classes, but we'll be focusing on the certain obviously, the attributes that you would be looking for in an attractive triple net investment. Okay. That's helpful. And back to Canada Square, just to touch on it, it sounds like it might even slip into early 2020 in terms of the actual closing of the increased interest. Is that something you meant to hit that in your comments, Ken? Yes. So, yes, I mean, at this point, it's we don't think at this point in the process, when you're getting close to the end of the fiscal year, it could tip over into Q1 for sure. Just a couple little ones to finish off here. Aurelia Square, it looked like the timing has been delayed a little bit there. Any update on what's going on there and leasing for the back fill space? No, the timing delay is actually mostly related to Canadian Tire's requirements to remediate their portion of the site. So they require a little bit of extra time to decommission the service center and provide it back to us in the condition that's required under the lease. So that was a little bit more onerous than we expected to be. And I guess it's too early to talk about backfilling that space at this point? Yes. Okay. And just finally, the Brampton expansion, just curious, that store looks like it occupies the full site already. How are you squeezing in another, I think it's 16,000 square feet? I believe that one's going to be a rear expansion. Rear? Yes. Okay. Thank you. Thank you. The following question is from Tal Woolley of National Bank Financial. Please go ahead. Hi, good morning. Good morning. Thanks. I just wanted to ask, we're sort of about 2 to 3 years in with Canadian Tire pushing its e commerce business in the mainline banner. And I'm just wondering, when you look at the distribution center strategy that they've got for their business right now, as the e commerce portion grows for the business, do you see any sort of changes to the distribution center strategy where you might see them having to develop like e commerce only DCs, that kind of thing that might involve C2REIT in the future? Hi, Tal, it's Ken. As we've mentioned earlier, both in this call and in other calls, we stay pretty close to Canadian Tire and their planning, including their plans for their supply chain and want to understand, continue to understand the implication is a very commerce strategy on their bricks and mortar network, both retail and supply chain. A very long way of saying there's nothing concrete to report in terms of how we might participate with Canadian Tire in their evolving plans. Suffice it to say though that to the extent that we can, we would like to participate. Thank you. The following question is from Himanshu Gupta of Scotiabank. Please go ahead. Hi, guys. Sorry, there's a follow-up here on Jenny Ma's question on the Class C units. So I know $200,000,000 is up for renewal in May 2020. Just trying to understand how is the agreement with CTC structured? I mean, in case it is automatically renewed for 5 years, so will there be a rate reset? And I mean, how will the new rate be determined? I mean, the reason I'm asking is current rate is like 4.5%, so there could be potential for interest rate savings there. Himanshu, it's Leslie. The rate reset does provide for renewal of those maturing at the end of May in 2020. The rate would be set based on market rates at that point in time. So such that if the current rate environment continued into 2020, yes, we'd expect to see some rate savings on the compared to the current rate that is in place for that sort of $250,000,000 Thank you. The following question is from Sumayya Syed of CIBC. Please go ahead. Thanks. Good morning, everyone. Just have the one question probably for Ken here. So you've obviously seen strong demand for the single tenant net lease type assets in the private buyer space. A couple of your peers have done some asset sales. Any thoughts there? Does that seem like something you could potentially do down the line? Hi, Sumayya. I wouldn't say that large scale capital recycling would be on our radar screen. I would say that it is quite possible that we might want to rotate out of some assets or markets and do some capital recycling going forward. But I don't think that what you've seen our peers do is necessarily something you'll see us do. Thank you. As there are no further questions at this time, I will turn the call over to Ken Silver, CEO, for closing remarks. Thank you, operator, and thank you all for joining us today. We expect our 4th quarter results will be released in the 2nd week of February. We look forward to speaking with you then, and we also wish you all the best for the upcoming holiday season.