Earnings Call: Q4 2019

Feb 28, 2020

Ladies and gentlemen, my name is Joanna, and I will be your conference operator today. At this time, I would like to welcome everyone to Artis REIT's 2019 Annual 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. Today's discussion may include forward looking statements, which include statements that are not statements of historical fact and statements regarding Artis REIT's future financial performance and its execution of initiatives to deliver unitholder value. 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 those statements. Please see Artis REIT's public filings for a discussion of these risk factors, which are included in their annual and quarterly filings, which can be found on ArtisSuite's website and on SEDAR. Thank you. I would now like to turn the meeting over to Mr. Armin Martins. Mr. Martins, please go ahead. Thank you very much moderator. Good day everyone and welcome to our Q4 year end conference call. Happy Friday to us all. Again, my name is Armin Martins, President and CEO of Artis REIT. With me on this call is Jim Green, our CFO Tim Mulaney, our EVP of Investments Jackie Craig, our SVP of Accounting and Phil Markman is joining us today as well, EVP of U. S. Operations. Again, thanks joining us and we'll start as always. I'll ask Jim Green to review our financial highlights and I'll wrap up with some commentary as well and then we'll open the lines for questions. So go ahead, Jim. Thanks, Armin, and good afternoon, everyone. So going back to our Q3 earnings press release in November of 2018, and it seems like it was a long time ago, but it's been a busy time since. So we've announced a series of new initiatives at that time for the REIT, and we're now over 1 year into that plan, and it's been a very busy time executing on the strategy. The impact of executing that strategy continues to impact our metrics and will for a few quarters yet to come. We are nearing the end of it, but we have some more assets yet to sell. We look forward to the continuation of the strategy in future quarters as the next steps will consist mainly of asset sales with the proceeds used for debt reduction. That should demonstrate continued improvement in our balance sheet metrics. Artis is a diversified commercial REIT, office, retail and industrial with assets in 5 Canadian provinces and 6 U. S. States. Based on the Q4 NOI, it was 52.3% weighted in Canada and 47.7% in the United States. And as the majority of future asset sales will likely be in Canada, we expect this ratio to continue to move such that greater than 50% of our assets will be in the United States. On an asset class basis, we're 48.6% weighted in office, 17.9% weighted in retail and 33.5% weighted in industrial. Artis continues to be active in both new developments and redevelopment of our existing properties. We have at the year end roughly $103,000,000 invested in projects currently under development. During the quarter, we invested a further $15,000,000 roughly into the development projects and transferred one property completed at the value of about $42,000,000 from under development to completed properties. As detailed in the MD and A, we have several new development projects that remain underway, including a new mixed use residential tower at 300 Main Street in Winnipeg, new industrial space in Houston and a small retail development as additional density on one of our retail sites in Winnipeg. Also as detailed in the MD and A, we have several development projects in the pipeline and the planning stages for construction has not yet actively started and these projects are progressing well through the development stages. We've been actively marketing our Calgary office properties with the goal of selling into the market at the best prices we can achieve in the current Calgary market. And pro form a the Q1 2020 dispositions that have now closed, this sector is down to a very small ballpark 2.1 percent of our total portfolio NOI. Disposing of assets in the Calgary market today has caused some further rate downs in value. However, we feel it's still the right decision as we think the Calgary market will require several more years to recover and stabilize before it sees growth again. We've been able to maintain our balance sheet with debt improving slightly from 52.6% last quarter to 52.3% this quarter. So small change, but moving in the right direction, despite incurring a fair value loss this quarter, caused largely by the sale of those Calgary office properties and also a foreign exchange loss, both of which affected our GBV. Debt to GBV is up a bit from 50.6% at December of last year, and the new driver of the increase continue to target a range of 45% to 48% for debt to GBV over time. Our EBITDA interest coverage also remains healthy despite carrying a bit higher debt at the current time. And with debt to GBV improving slightly this quarter, we also achieved an improvement in the debt to EBITDA ratio as well. We're pleased to see that trending in the right direction. Despite the dilutive effect of asset sales, the unit buyback program combined with good same property growth and completion of some of our development properties is having a positive effect and FFO came in at $0.37 this quarter, up from $0.34 last quarter and up from $0.33 in the comparative quarter last year. AFFO for the quarter was $0.25 up a $0.01 from the same quarter last year. Our payout ratios for the year are very conservative, 38.3 percent of FFO and 51.4 percent of AFFO. Just coming back to those initiatives for a moment. On November 1, the series of initiatives announced included increasing unit values by increasing NAV and continuing to focus on the quality of the portfolio. The distribution was reset at that time to $0.54 annually, resulting in a very conservative payout ratio and freeing up cash to fund our development pipeline. Plan also included non core asset sales of between $800,000,000 to $1,000,000,000 and this process is well underway. We've completed and closed on $603,000,000 of sales to December 31 and have closed a further $118,000,000 subsequent to the quarter end. We have a further $22,000,000 under unconditional contract set to close in February. Basket of properties as listed as held for sale at December 31 was $222,000,000 including the properties just mentioned as closed and some furthers that are in various stages of sale with some under conditional contract. We anticipate most of these will sell over the next 2 to maybe 3 quarters. Initiatives also included using a portion of the sales proceeds to buy back our units under our NCIB and we accelerated this progress portion of the plan by starting immediately after the announcement in November in advance of asset sales. And from last November to December 31, we've repurchased almost 16,000,000 units at a cost of just over $173,000,000 We used our line of credit to fund these purchases and plan on repaying the line as assets are sold. In addition to the NCIB purchases, we redeemed the maturing series of our preferred equity at a cost of $78,400,000 If you include the redemption of preferred equity with the common equity, we basically met our target for equity redemption. Proceeds of asset sales will be focused on debt reduction in the near term. However, we have renewed our NCIB and we are in a position to purchase further equity if circumstances are favorable for that. In our opinion, the plan is on track and ahead of schedule. Touching just for a minute on a couple of operational numbers and then I'll pass it back to Armin. So fair value of the investment properties on the balance sheet at fair value this quarter was a net adjustment of approximately $20,000,000 We didn't record some further gains on our industrial properties. However, it was offset by some reductions needed to get to the net realizable value in today's market of the Calgary office properties. We remain very comfortable with our debt to GBV ratio. It's starting to show improvements as we continue to sell properties and we expect this to continue into future quarters. Still dealing with the temporary effect of using line of credit to fund our NCIB until such time as purchases are received from asset sales. And we also use the line of credit to redeem the Series G preferred units, also planning to repay that from asset sales. We've been gradually paying off mortgages and reducing our secured debt to GBV. So as of December 31, our unencumbered property portfolio was valued at 1,960,000,000 dollars On the financing side, we have a $700,000,000 unsecured revolving credit facility with a syndicate of lenders and 2 non revolving credit facilities in the aggregate amount of $300,000,000 Both of the non revolving facilities are drawn in full and we place swaps to fix the interest rates in those facilities as we expect to be outstanding for the full term. Touching briefly on same property, we had a great year and quarter for same property results. So for the quarter, the results were up positive 3.2% this quarter in functional currency. And when we factor in support and exchange gains, it was a positive 3.3% in Canadian dollars. We also presented a stabilized same property calculation, which eliminates both the properties planned for disposition, as well as the Calgary office sector. And on this basis, we had growth of 4.4% in functional currency and it was the same number 4.4% once FX was factored in. Our Industrial segment continues to show the strongest performance in both countries with 9.4% growth this quarter in Canada and 6.3% growth in the U. S. This now represents 6 consecutive quarters of positive same property growth for us and we are pleased to see that progress. Touching on the net asset value, as we report our investment properties at fair value, we can calculate a net asset value per trust unit just simply using the equity on our balance sheet less the equity held by the preferred unitholders and divided by the number of common units outstanding at the end of the quarter. If you do that math, the net asset value per trust unit is $15.56 only a penny from $15.55 at the start of the year. It seems interesting to see only a one penny change, but there were a lot of moving parts. Foreign exchange for the year contributed negative impact on net asset value of $0.44 and the fair value loss was a further 0 point $4.5 offsetting that was a gain of roughly $0.40 due to our NCIB purchases and the remaining gain from the fact that our income excluding fair value and foreign exchange, was in excess of our distributions and also contributed to net growth in NAV. Novartis ended the quarter with roughly $51,000,000 cash on hand and $112,000,000 undrawn on our line of credit, and we've got several subsequent events detailed in our notes to the statements, which we believe continue to reflect our strategy of intelligent recycling of capital. We plan to continue our focus on a strong balance sheet and the overall quality of our portfolio. And that completes my financial review. We feel the initiatives announced in November 2018 will make Ardas a better and stronger group. And we look forward to demonstrating that in future quarters. I'll pass it back to Armin for a little more. Thanks, Jim. And also, I'll just add commentary from me. Again, folks on balance, we feel we've done very well this year over last year, delivering a total return to our investors of about 35%. We've made good progress on all fronts and delivered strong performance metrics for our unitholders. So we've printed, as Jim mentioned, 6 consecutive quarters of same property NOI growth. Our weighted average rental increases are healthy. Our all solid numbers of growth and growing well. Our debt metrics improved just a little bit quarter over quarter. Looking ahead, given our very conservative payout ratio and the progress we've made on our strategic initiatives, debt reduction will be a top priority for us. We do feel that by the end of this year, can bring it down to 45% to 47% of our book value. And that should be well received by the investment community. Again, you'll recall some key strategic initiatives we announced over a year ago, and of course, we made very good progress on all fronts. Distribution continues to be ultra low conservative and bulletproof, especially in these times when investors may be nervous for a lot of reasons. There are there for a lot of reasons to take a hard look at artists given our bulletproof payout ratio. Our unit buyback program went very well. Our property disposition program, of course, went very well and continues. It is business as usual. We announced $800,000,000 to $1,000,000,000 of dispositions, and we're not there yet. But we've completed 750,000,000 dollars on time and on price to correspond with our IFRS NAV of $15.50 Very good number, which compares, of course, very well to our unit price. And we're talking about assets that are tough to sell. I mean, the easier the low hanging fruit is still ahead of us. So I think we've demonstrated continue to demonstrate very good value as we progress with our disposition program. It's important to note, of course, that as our financial metrics improve, so is our portfolio of properties that is above real estate. We're reducing our office and retail meaning, increasing our ownership of industrial properties, also reducing the number of secondary markets we're in undiversifying, if you will. Our Calgary office exposure is consistently shrinking, will be 2% at the end of Q1, and by the end of this year, it will be down to 0. Our remaining retail investments will be open air service sector properties in Western Canada only, which we feel is a very good focus for us. Meanwhile, our overall portfolio is performing well and our industrial development pipeline is on track to deliver excellent results. Also, we invite you to look at our MD and A and investor presentations for more color here. So looking ahead, folks, we will continue to work hard to keep our buildings full whilst bringing the rents up to markets and consistently streamlining and improving our portfolio of real estate. To be clear, the integrity of our balance sheet, our earnings growth and implementing our strategic initiatives continues to be of utmost importance to us. So that's our report for this quarter year. We're pleased with the results and the progress we're making on all fronts. And I'll now ask the moderator to take over and fill your questions. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Your first question is from Jonathan Kelcher from TD Securities. Please go ahead. Thanks. Good afternoon. First question, just on the I guess there's $100,000,000 or so left held for sale on the balance sheet. Would that will that effectively once you guys sell that will that effectively end the asset disposition program? It will end the what was announced under the strategic initiatives. But over the years, we have consistently sold anywhere from $200,000,000 to as much as $400,000,000 of assets per year and recycled the capital. That plan would probably continue. There's always more recycling to be done, John. It could be at that point in time, the Board will take a good look and see what the next step is. It could be we'll double down on our strategic initiatives or it could be we'll just continue as we have in the past, recycle between say $200,000,000 to $300,000,000 of our properties and improving our portfolio that way. Okay. But I'm assuming that would entail either buying or like if you're going to sell $200,000,000 to $300,000,000 you'd be looking to put that into either development or new acquisitions? Primarily debt reduction, we got to get our debt down. That's we've been promised a much higher price, Marco, when we do that. And we'll get that debt down to 45% and then selectively grow, and we will be growing in the industrial sector primarily. Okay. How high a percentage would you like to are you like industrials are up 30% right now, how high would you want to get that? At least up to 40. And after 40, we'll take a second look and maybe bring it up to 50. Okay. Sounds like what you guys did when you went into the U. S? Kind of, I guess. And the opportunity opportunities are here. We're actually acquiring additional development sites, industrial development sites right now in Phoenix and Houston and in many offices. We expect to grow our industrial development pipeline. We're still achieving 7% unlevered yields. Buildings we're building the buildings. We're planning them well. We're building them. We're leasing up and delivering great value for our union holders. Okay. And then just one little modeling question. The G and A was it came in pretty good in Q4. What would be a good run rate for G and A for 2020? That's always a bit of a tough one to project. I guess if you take out the swings that can be created by the unit based compensation fair value number And in particular, the special committee, whatever they choose to spend, I would say we'd be running in the $3,500,000 to $3,000,000 a quarter range. Okay. That's it for me. I'll turn it back. Thanks. Thank you. The next question comes from Matt Logan from RBC Capital Markets. Please go ahead. Thank you and good afternoon. Hello, Matt. Armen, on your comments, you mentioned that you're targeting a 45% to 48% debt to GBV. Did you say that was by the end of 2020? Yes, I did. And so could you help us reconcile that figure with your comments for $100,000,000 of dispositions because by my back of the NatGen math, you probably need to do $300,000,000 to $400,000,000 to hit that target. Yes, I think you heard me also mentioned that traditionally we do $200,000,000 to $300,000,000 a year as well anyway. So that's what I'm thinking. On our plan and then you should expect us to do what we've done in the past, another $200,000,000 to $300,000,000 I got it. Right. To get to the 45% is about a further almost $600,000,000 of asset sales. And so the $600,000,000 of asset sales will be kind of what you've gotten held for sale today plus what you see as normal course dispositions but without the acquisitions? Yes, that would be over the next 2 years, let's say. I think we can hit that. Okay. The last numbers are right. And maybe just changing gears here a little bit. Your Calgary office exposure is down to just 2%. With that portion of your portfolio effectively in the rearview mirror, do you think negative fair value marks are also a thing of the past? Getting there, getting there. Yes, we feel we're stabilizing in terms of our NOI very nicely and in terms of our NAV. And on the NOI, it seems like the organic growth is trending ahead of your 2% to 3% guidance. Do you see any chance that that might actually come in better than that number in 2020? Yes, we're optimistic. We've been reluctant to give guidance in the past, but we're optimistic that we can beat. And would that be driven by the office portfolio given there's maybe a little more occupancy upside in that segment of the business? Industrial will still continue to lead. And then our retail will do better this year than last year. Okay. And maybe last one for me in terms of just a modeling question. Can you guys give us any color on the interest income this quarter? Sure. So we carried a vendor take back mortgage on the sale of €415,000,000 as well as a smaller vendor take back on the sale of 805. So that's contributing to the extra interest income. So should we expect that to be recurring next quarter? Yes. It's a 3 year term on that DTV. The next question is from Jenny Ma from BMO. Please go ahead. Thanks. Good afternoon. So I know the Calgary office segment is largely behind you, but I just wanted to get some color on how we should look at valuation in terms of the Calgary assets you sold. It looks like the cap rate came in at about 9% to 10%. But could you talk to us about the occupancy and the term that's remaining in there and maybe how pricing was determined? Was it still based on in place cash flow or was it more on a price per square foot basis? You're talking about the TransAlta building? I'm talking about the ones that you guys did subsequent to year end actually, January, the recent one. Yes, okay. Yes, I mean, they're behind us. The trans out of building is the one that impacted us the most, was 100 percent occupied, 3 years left to go on the lease just a shade under 3 years. They had already given us little notice that they're leaving. I think they're moving very shortly into another building. And so we just did the math. The sensitivity analysis the cost involved, the IRR, and we just kept the cost involved and the IRR and we just came to the conclusion that the price we sold at that was the right price. Now meanwhile, on a short term basis, it's a high cap rate. We're just that's too bad. But that can was leaving anyways, and we were going to experience some pain. We thought the best time to crystallize a value would be right now and so that's what we did. Okay. And can you just give us some general color on how investors are approaching valuation in Calgary office? Like I said earlier, is it really looking at the in place cash flow or is it on a price per square foot basis? In this case, it was a combination. There's some carrying income. The carrying income there, they get paid while they wait, while they plan to redevelop and lease. I'm hoping the buyer has a lot of success. They have a strategy to lease it to that companies and others. But generally, it's a price per square foot for sure, other than 9 out of 10 times. And they're looking then at the leasing cost, how long it takes to lease, not just the cost to buy a tenant and their IRRs. And the cost per square foot, I'd say they've come down in Calgary in the last year after year, quarter after quarter, they haven't gone up. I don't think we've seen a bottom yet in terms of valuations. And in that sense, we're satisfied that we've done the right thing and basically getting out of the Calgary office market. Okay. That's good color. Turning to industrial, I know you've mentioned in past conference calls that you've gotten a lot of unsolicited inbound interest on industrial. Just given markets this week aside, just given the strength and the demand for industrial assets and your versus your desire to grow that asset class, I'm just wondering for a good portion of your industrial assets, is there a price that you would be willing to sell it at? Or are you more committed to expanding the strategy that you'd want to hang on to all of it? Well, it becomes a question of how much lead on your cash and growth right now. If we bring it down to 4 or 5 and look at our portfolio of $1,800,000,000 it goes up to about 3 point $2,300,000,000 in the over a 5 year period, creating NAV increasing NAV of $3 per unit. That's just our industrial portfolio. If we just manage it optimally and grow it in a conservative manner in the next 3 years and never mind building more industrial and I said I mean the next 5 years rather. So then what's that growth worth that you like to give away all that away now, what's the worth to today, what's the present value of that. So I don't know if somebody gave us a 4 cap on all of our industrial, I guess we'd look at, but if they're saying it's 5 on all of our industrial, we're going to say, well, we can do a lot better by holding and managing ourselves, but we'll give you a better deal around retail if you want our retail. And what has the has the volume of inbound calls been about the same or more or less for industrial? Yes, it's always there. I mean, we can sell our industrial before dinnertime tonight, any day of the week, right? It's always there. But if we were really interested in selling just industrial, that would be basically a global marketing process there. As I said, we have conservatively about $1,800,000,000 of industrial right now, and that's a good chunky portfolio. It's a great it's a long diversified portfolio in terms of kind of mix and building type. And it's an ideal portfolio for anybody. So we're not entertaining it right now. Okay. And then lastly, do you have any update on any conversations you've had with the strategic review committee, anything you can share with us? So that's a fair question and we have a scripted answer for you. So again, none of us on the management team are on the members of the special committee nor are we spokespeople for the special committee. You can see by our financial statements that they're busy and they're working. You know they've hired advisors and you can do that to ensure they're being as productive and efficient as possible and that as soon as they have something material to announce, they will be doing that. But otherwise, I can't say anymore. I think previously you had mentioned a timeline sort of mid year. Is that still the case? Well, if I did, I'm not officially I can't officially predict anything, but they started last year and I think the best benchmark you have is to look at industry practice, what other special committees have done for under weeks and how long it takes and you can use that as a guideline. But they got started last year in August. And I think there's any good reason for investors to be patient and optimistic. Okay, great. Thanks. I'll turn it back. Thank you. The next question is from Mike Markidis from Desjardins. Please go ahead. Just on Tower Business Center, I guess, the industrial property that came on stream in the Q4. Jim, do you have a sense of when like was it a full quarter contribution for the space that came online or was it back end loaded? So Tower was it's 2 building portfolio, 1 is 100% leased, the other one is not leased yet. But the first building did come on stream, but I think it was for the whole entire quarter, is that right? For the Q4, yes. Yes, October. Sorry, so there's 2 buildings that are leased, one came on stream and then the second? 2 building portfolio, one's leased and the other building that's leased came on stream. So Tempur Sealy took the whole of the first building of 289,000 square feet October 1. And the second building is completed, but it is vacant and we are getting very good traction for our lease activity. So we hope to have that leased up this year. Okay. And then, okay, so beyond that, I mean, in terms of your plan to keep growing the industrial portfolio, I guess, first question would be just looking at your developments that you have underway right now. You've still got a little bit of space left at Park 895 that you could do, but there isn't anything else active. So should we be expecting some more activity to percolate as the year goes on? Yes. I mean, we just got to face the rest of Tallahas and leasing up. But you're right, we just bought another 40 acres adjacent to Park Lucero here in Phoenix. And it was a 40 acres, right, Phil? 37%. Okay. Yes. And so we've got plans to do about 400,000 square feet of industrial there, So it's about $500,000,000 $400,000 square feet. It blends in very well. It gives it good efficiency for our park to sell So we've got that coming up and we'll get that ramped up this year at least to commence whatever we'll get mobilized. And then we're bidding on properties in other markets that win such as Minneapolis as well. We're a little bit behind and we're careful with new investments and new developments. We don't we can't over develop, we can't under develop because we're also working on paying down our debt. Okay. And then is your future growth in industrial all planned for U. S. And all planned through development or are you contemplating acquisitions as well? Yes, yes. And back to what at that point, as we get our debt down, we're about to ramp up our development pipeline. Right now, we're focusing on the U. S, Canada selectively. The barriers to entry are high and the IRRs are pretty low in Canada, but we're doing very well with our U. S. Development pipeline. And as we paid on that debt, we expect to ramp that up even more and grow it more. Okay. Just thinking about obviously, you can't give an update in terms of what the strategic committee is doing. But have you given as a management group, have you given any thought to in the event that well, I guess as part of the strategic review, you must be proposing one alternative at least, which is course of action if this company is not sold, would that be correct? That's always a consideration. That's definitely a strategic consideration. Okay. And so on that, are you able to discuss what your ideas are in the event that it doesn't result in the sale with the how you would change? I mean, you put out a plan that you've executed quite well on. The market arguably hasn't necessarily given you any credit for it or not the credit that you'd want to see. So with that in mind, how does that change or how does that impact your thoughts for the I won't call it the status quo for the going concern plan if in the event that there's no sale transaction? So I mean, anything material would have to be approved by the Board before we can discuss it. But of course, the path that we're on now is to shrink office selectively, shrink retail selectively and to grow industrial, of course. And as we dispose of assets to pay down debt, fix the balance sheet, and then once that's fixed and stabilized, we can ramp up growing our industrial. And so I think that gives a good perspective. I couldn't say much more than that. Okay. And then just last one for me before I turn it back. Just in terms of the sales, obviously, you've got assets for sale. We know the $100,000,000 or so, I can't remember the exact number, but you completed some and there's another 100 or so million left to go, but another sort of 600 ish, I think, was the number to get down to your planned debt target. And I know you're talking about Canada. So can you give us a flavor as in terms of what assets would be included in that other 600? Is it specific markets or regions? I mean, it sounds like industrial isn't one that you want to look at, but is it specific cities? Is it specific is it retail versus office? Just given a sense of what you got planned. So not much more color. I mean, it will be more office. I mean, as you mentioned, we want Chicago office down to 0. But there will be more office. And I don't want to keep telling you what city, but primarily in Canada, more office and then more retail on both cases on a select basis. And when we get to that point, we'll probably identify the properties quite clearly and as the metal we'll get to that at Q1. And at this time, we have no further questions. Please proceed. All right. Well, thank you again, everyone, and a happy Friday to us all. Hope you all have a good weekend. Crime shame about what the markets are doing to us, but as much as life, I'm sure we will all come out of this just well. So thanks again for your interest and keep saying good things about us. Keep showing an interest in Artis Wheat and everyone have a good weekend. Talk to you soon. Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending.