Earnings Call: Q1 2019

May 10, 2019

Good afternoon, ladies and gentlemen. My name is Leonie, and I will be your conference operator today. At this time, I would like to welcome everyone to Artis REIT's First Quarter 2019 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. Thank you. Today's discussion may include forward looking statements, which include statements that are not statements of historical facts 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 such statements. Please see Artis REIT's public filings for a discussion on these risk factors, which are included in their annual and quarterly filings, which can be found on Artis REIT's website and on SEDAR. Thank you. I would now like to turn the meeting over to Mr. Armin Martin. Mr. Martin, please go ahead. Thank you, moderator. Good day, everyone, and welcome to our Q1 2019 conference call. So again, my name is Armin Martins. I'm the CEO of Artis REIT. With me on this call are Jim Green, our CFO Kim Briony, our SVP of Investments Jackie Koenig, SVP Accounting as well as Heather Nichol, Vice President of Investor Relations. So again, thanks for joining us. I'll start again. As in the past, I'll ask Green to review our financial highlights, then I'll wrap up with some market commentary, and we'll open the lines for questions. So go ahead, Jim. Thanks, Armin, and good afternoon, everyone. So as I'm sure the majority of people on this call are aware, our Q3 earnings press release back in November of 2018 announced a series of new initiatives for the REIT. And as this was a relatively quiet quarter and I expect most callers would prefer to spend time on those status update on those initiatives. I'm going to keep my comments on the financial operating results fairly short, but happy to answer questions if anybody has detailed questions later. So Artis is and remains a diversified commercial REIT with assets in the 5 Canadian provinces and 6 U. S. States. Based on our Q1 NOI, the REIT was 53.7 percent weighted in Canada and 46.3% in the United States. On an asset class basis, it's 53.1 percent in office, 20.1% in retail and 26.8% in industrial. We do continue to have a presence in the Calgary office market, although it's becoming a small component of our operations. For Q1, it's down to 6.1 percent of our NOI. And I'm kind of pleased to say that our MD and A usually discusses our top 5 segments and Calgary office is no longer one of our top five segments. So nice to see that shrinking to a manageable level. And looking at that Calgary office because it's always a very difficult market, we have relatively small exposure to our current tenant maturities in the near future. We only have roughly 112,000 feet that will mature in 2019 and only 48,000 feet of space in 2020. Artis does continue to be active in both new developments and redevelopment of our existing properties. We currently have approximately $202,000,000 invested to date in projects currently under development. During the quarter, we invested of that $50,000,000 was invested into the development projects this quarter. As detailed in our MD and A, it's several different development projects underway, including a new residential and mixed use tower in Winnipeg at 30330 Main Street and new industrial space in Houston, Phoenix and Denver. As detailed in the MD and A, we also have several development projects in the planning stages where we have not actively started construction and these projects are progressing well through the development stages. We've been able to maintain the strength of our balance sheet. Debt to GBV is up slightly this quarter to 51.7% compared to 50.6% in December of last year. And the main driver of the increase in debt to GBV has been timing of the purchases for our planned unit buyback compared to the asset sales, and I'll discuss the asset sales in a little more detail in a minute. So we anticipate bringing that debt to GBV back under 50% as the asset sales are completed. Our EBITDA interest coverages remain over 3x despite carrying a bit higher debt at the present time. The unit buyback is definitely having an impact, and FFO came in at $0.34 this quarter, up from $0.33 last year. Might be only $0.01 but I'm pretty happy to talk about an increase in FFO because it's been a while since we got to do that. So very pleased to see the impact happening in increases in FFO. AFFO for the quarter was $0.25 actually up $0.01 from last quarter as well, but unchanged from Q1 of 'eighteen. Payout ratios are very conservative, 41.2 percent of FFO and 56.0 percent of AFFO. So coming back to those initiatives, specifically in November 1, 'eighteen, we announced the series of new initiatives aimed at increasing cash flow and increasing unit values and improving the focus and quality of the portfolio. The distribution was reset to $0.54 annually, resulting in a much more conservative payout ratio and freeing up cash to fund our development pipeline. The plan announced also included non core asset sales of between $800,000,000 to $1,000,000,000 and this process is well underway. As you may have noted, at March 31, we had already moved $518,000,000 of properties into the held for sale, and we anticipate most of those will sell over the next two quarters. And in a subsequent events section, you'll note one is already closed and further properties have been added to the group of held for sale, bringing it up in excess of $800,000,000 So well along the line of our targeted between $800,000,000 $1,000,000,000 of asset sales. That was sort of a 2 to 3 year target. So we should be well ahead of schedule on getting that done. Initiatives also included using a portion of the sales proceeds to buy back our units using our NCIB, and we started this immediately after the announcement last November. So from last November when we announced it to March 31, we had purchased 9,100,000 units at a cost of just under $94,000,000 We used our line of credit to fund these purchases and plan on repaying the line as the assets were sold. Unit purchases have continued in April May using the maximum amount available under our NCIB. So in our opinion, the plan to buy back units is also on track and ahead of schedule. I'll just touch on a couple more highlights and then pass it back to Armin. Debt to GBV, I think I've covered in my opening comments, so nothing further. Unencumbered assets, the REIT has we paid off one additional secured mortgage this quarter by bringing the unencumbered asset pool up to 1,900,000,000 dollars We have fairly good liquidity. We have a $700,000,000 unsecured revolving credit facility and 2 non revolving unsecured credit facilities for a further $300,000,000 The non revolving facilities are drawn in full with swaps placed to fix the interest rates. Same property this quarter, we were very pleased with, positive 5.1 percent in Canadian dollars and translating that back to functional currency or the mixed dollars of Canadian U. S, was still a nice positive 2.9%. And we also present a stabilized same property calculation, which eliminates the properties planned for disposition or repurposing as well as the entire Calgary office sector. And on this basis, growth was 3.3% in functional currency and up to 5.7% once FX was factored in. Industrial segment continues to show the strongest performance with 3.4% growth in Canada and 10.1% growth in the United States. Other comments would be the net asset value. We report our investment properties at fair value under IFRS and accordingly can calculate a net asset value per trust unit. So simple calculation of taking the equity on the balance sheet less the equity held by preferred unitholders and dividing by the number of common units outstanding at the quarter. And the net asset value per trust unit came in interest only and up at $15.55 which is exactly unchanged from last quarter, although there were a number of movements in both directions. Specifically, foreign exchange, the Canadian dollar strengthened a little bit during the from where it was at year end. So there was a decrease in NAV of roughly $0.16 from foreign exchange conversions. The distributions were based on the units outstanding at the end of the quarter, a reduction in net asset value of roughly $0.16 as well comprehensive income in excess of the fair values and foreign exchange and financial instruments kind of the non cash items was a $0.34 positive and we had a gain from the preferred units we canceled, roughly $0.02 and roughly $0.18 gain from the NCIB on the common trust units. So a whole bunch of things moving that NAV in both directions, and it still comes in at the exact same number as Q4. So I think that's about it. We ended the quarter with pretty good liquidity. We had 51 $1,000,000 undrawn on our line of credit and several events detailed in the subsequent events note, which we believe continue to reflect the strategy of intelligent recycling of capital, plan to focus on the strong balance sheet and the overall quality of the portfolio. And that pretty much completes my financial review. So I'm going to turn it back to Armin for some further discussion. Thanks. Okay. Thanks, Jim. So folks, on balance sheet, you can see we feel off to a very good start this year. We're working hard on all fronts and feel we're getting good traction and making good progress for our unitholders. So again, you'll recall some key strategic initiatives that we announced in Q3 last year, and we're pleased to report that things are going well on all fronts. First of all, the distribution has, of course, been reset to a stabilized AFFO payout ratio of under 60%. And this is, in fact, the lowest payout ratio in the REIT sector. Given our earnings profile, we feel this is quite a bulletproof payout ratio right now. Our unit buyback program has, of course, been active and successful. Our 3 year target was to buy just 23,500,000 units at an average price of 11.50 dollars And to date, we're already about halfway there. However, at an average price of $10.35 So needless to say, we're pleased with our progress, and it's highly accretive to be buying back at the price we are right now and puts us this also again puts us well ahead of plan. Property dispositions, this program is making good progress. Our target is to sell $800,000,000 to $1,000,000,000 of non core properties over the next 3 years. So a lot of wood to chop here. But we've done it before, and we are doing it again. Thus far, about 20 listing agreements have been signed, 5 properties sold for about 200,000,000 dollars 7 more under conditional contract for about $330,000,000 and active negotiations taking place on several more properties. We're confident of being able to sell over $600,000,000 of properties this year alone on time and on price to correspond with our IFRS NAV of over $15 which again would put us well ahead of plan. And nobody should be surprised if we do even better and finish at all in by the end of this year in at least in principle. So meanwhile, our portfolio is performing well. Our earnings profile is improving. The office markets that we're in are somewhat inconsistent, but this is the year, folks, this is the year that our Calgary office portfolio will stabilize and begin contributing to our organic growth even if it's just a little. Meanwhile, our retail and industrial portfolios have a very good track record and continue to deliver organic growth, and our industrial development pipeline is on track to deliver good results as well. We invite you to look again at our MD and A and investor presentations for more information here. So looking ahead, we will continue to work hard to keep our buildings full whilst bringing the rents up to market, consistently and consistently streamlining and improving our real estate portfolio. To be clear, integrity of our balance sheet, our credit rating and implementing our new strategic initiatives is of utmost importance to us. A brief word about our the special committee that we announced has been formed. So the Board has formed a special committee of 5 independent trustees to review and consider strategic alternatives in addition to the initiatives that we're implementing now. Again, it's all about maximizing unitholder value. If you look at our earning our improved earnings profile and our portfolio, we have almost $2,000,000,000 of great industrial properties. We've got $1,000,000,000 of well performing retail properties, about $3,000,000,000 of stabilized office properties. You look at these sectors, we're trading at a multiple of 10x or 11x AFFO compared to industrial REITs trading at 16, office 17, retail 14. So we're not even close to a multiple of one of the asset classes that we own. So this mispricing is not only silly, it's also annoying, and the Board is going to work hard. And the management team will, of course, work hard to narrow the gap between our current price and our true value. So that's enough on that front. Again, that's our report for this quarter, folks. We're pleased with the results and the progress we're making on all fronts and of course, confident in our outlook. I'll now ask the moderator, Leonie, to take over and field your questions. Thank you. Your first question is from Jonathan Kelcher from TD Securities. Jonathan, please go ahead. Thanks. Good afternoon. First question, just on the special committee, was that formed in response to anything in particular? Or is that more of a proactive or more of a proactive basis? A combination. In principle, proactive. We announced our distribution cut in our new initiatives in Q3 last year. We're trading in the $11 range then. And even though we've been buying back our units, Jonathan, at a rate of 3x the value of our distribution cut, we're still trading below where we were when we first cut. So that's just not good. We've been monitoring that. We're surprised it even went down. So that's one thing, one consideration. And then the other consideration is, yes, there have been some inbound calls and interest expressed in the REIT. And so it behooves the Board to be proactive and stay in front of that kind of activity. Okay. Are you guys are you negotiating anything right now? No, no. No, no. We're not happy to announce on that front. I mean, the Board has not yet engaged financial advisers. They'll be going through that process. That will take 30 to 60 days. And I think at Q2, you'll hear a lot more about the steps being taken, but we are not negotiating with anybody right now. Okay. Fair enough. And then just you're up to the 800,000,000 dollars I guess and over $800,000,000 in assets held for sale. Couple of questions on that. Does the do the assets held for sale, does that include any of the ones where you were looking to get rezoning done and then you were going to list them, taking 415 Young and a couple of the others? The answer is yes, for sure, yes. And there's great interest in these properties even before we get the rezoning. And so they're definitely on the table. Okay. And then secondly, how much NOI would be associated with the or current NOI would be associated with the assets held for sale? Maybe just give you a rough cap rate instead. Or either or is just We do a rough calculation there. Kim will give you the number. I mean I'm getting a number around $40,000,000 around $40,000,000 of NOI for properties held for sale. You're talking the whole $850,000,000 I think if the stuff transferred afterwards, it's probably a little higher than that, Kim. I think we're closer to the $48,000,000 range on the entire bucket of properties that have been transferred into held for sale? Okay. About $48,000,000 Okay. And that would include the stuff that's sold post Q1, right? Correct. Okay. Thanks. I'll turn it back. Thank you. Your next question is from Matt Logan from RBC Capital Markets. Matt, please go ahead. Thank you and good afternoon. Yes. You guys are off to a great start with your disposition program. Can you talk a little bit about what your plans are for the proceeds this year when some of those funds start rolling in? So we'll continue maximizing our unit buyback. It's an automatic unit buyback. And when we get opportunities, and we do, we'll look at a block sale across as well. As we get near to say 3 it's a function of the unit price, how high we're trading as well as the number of units we bought back. But the next is debt reduction. We want our debt first goal is to keep it below 50%, of course, the GBV, but we want to get it closer to 45%. And then after that, an SIB is not off the table, but with a very conservative payout ratio we have, the next thing is to make sure our debt is on the conservative side as well and then we'll look at other alternatives. And the SIB, would that be a consideration after you guys get below 50 or after you get below 45? I'd say somewhere between 45 and 47, that kind of thing. Okay. And if you manage to sell all of the bucket of held for sale assets this year, do you think there would be more as we move into 2020? Not necessarily. If we get if we can go up to about $1,000,000,000 We have to watch our EBITDA and our debt metrics. Maintaining our investment grade credit rating is still job 1 for us. We don't want to give that up. So I don't see us selling more without a good reason. And I guess, lastly, in terms of the cadence of some of the transactions closing, how should we think about that in the balance of 2019? Sorry, the question is how close how quickly you close on that. Well, the pace, yes. Well, for us, deal certainly is number 1. If they take a little time closing, it's not the end of the world because we still enjoy the NOI. It will I think it will on balance 3 quarters would there will probably be some things closing the following year, right? If you look at the whole package and there's always closings always take a little longer sometimes, but sort of a and that's not a problem at all. Once we've got certainty on a deal, a nonrefundable money in our pocket, as a minimum, we'll be able to move forward with that. We continue can continue to move forward with our unit buyback. And then as the money comes in, we'll use it to pay down debt. So it'll be lumpy, but so there might be a 90 day to even 180 day trail in terms of some closings, but at least we'll have deal certainty. Of course. Totally makes sense. And in terms of your development spending, do you think the $50,000,000 invested this quarter would be a good run rate for the balance of the year? It will probably be lower than that. There are some developments. There is the Phoenix one is now done. The one of the ones in Houston is almost done. Tenant will take occupancy in May, I believe. It's in June, I think. So anticipate it will be a little smaller in Q2 and probably even smaller yet again in Q3. Well, I appreciate the color. That's all for me. Thank you very much. Thank you. Your next question is from Matt Kornack from National Bank Financial. Matt, please go ahead. Hi, guys. Just to follow-up on that line of questioning with regards to the development timing, how much has been spent on those projects that are about to come online? And what was the yield on that investment? I don't remember, Tim? I don't have The development our development on industrial, the development yields are coming north of 7%. I was going to say generally hitting a little above a 7 percent yield on the industrial developments in the U. S. And you've spent about, I guess, over they've ramped up over the last few quarters, and I guess it's industrial doesn't take too long to build. So I guess we should assume sort of $100,000,000 to $200,000,000 with that type of yield over the course of 2019? Is that a I know that's a broad range, but I don't think it'll be that much. I mean Denver is half built right now, and that's 220,000 square feet. And Houston, we've Phase 2 to get done. We're getting ready to do a build to suit for another for a large credit tenant of another 100,000 square feet. I don't think it won't be that much. But to this point, Q2 and Q3 will be a bit lower. I'm expecting Q4 will be back up as we ramp up another phase in Houston. Okay. Fair enough. Go ahead. No, sorry. I was going to completely change, so if you had something else to add on that. I was just going to say, it's hard for us to predict because the timing of the next start of another phase, that can vary. But go ahead. Fair enough. I mean, if at some point when you look at your MD and A disclosure, if it's possible to give a sense as to how much has been spent versus cost to complete and yield on the total project that it would just make our lives a little easier for modeling it, but just to note. And then with regards to CapEx on the remainder of the portfolio, it seems to have come down. I mean, maybe that's a function of you sold some assets in areas that were more difficult to lease. But what's your view on CapEx for the overall portfolio as well, including leasing costs? We're budgeting less this year than last year. I think our CapEx budget is down fairly substantially from last year. Yes. And part of that is to shrinking our office portfolio and in particular our Calgary office portfolio. Fair enough. That makes sense. And in terms of after sort of the pro form a artist, what does it look like? And what's your outlook? I guess once you've gone through this, what do you want to be? Do you want to be more development focused? Are you going to be in Western Canada and U. S. Entity? Just interested in the overall sort of theme to ARTIS going forward. Yes. At the end of the plan, you'll see us go from 45% Canada to or 45% U. S. Up to 50% or even 55% U. S. Just by virtue of the fact that we're selling mainly Canadian properties. In terms of what we're selling, it's office and retail, no industrial at all, and we want to grow industrial on the development side. We don't see ourselves with our cost of capital being able to afford to buy industrial, but we can develop slowly but surely. And new generation industrial, it's all our projects are performing very well and again, it yields north of 7%. So looking at the end of the plan, you can see us being 55% U. S, 45% Canada, so us being 40% industrial and 15% retail. That brings it down to about 45% office after that. And we'd still be diversified in order to maintain the credit rating. For us to do anything more strategic after that involves the whole REIT or involves big chunks of the REIT portfolios of the REIT and involves rethinking our line of credit and things like that. Fair enough. Okay. No, that makes sense. And then just one quick point of clarification. So $48,000,000 on $850,000,000 total sales, so about a 5%, 6% cap rate on what you've sold or in the process of selling at this point? Right. Again, it's still lumpy. Some of these things are coming in below our IFRS NAV and some are coming in above. But on balance, the cap rate is going to be in the sub-six percent on balance, right? So that makes it very accretive to be selling these assets. Yes. No, that sounds pretty good. Thanks, guys. Thank you. Your next question is from Neil Downey from RBC. Neil, please go ahead. Thank you. Hello, everyone. Just given the accelerating cadence of the disposition program, are there any tax constraints or any tax factors that we should be cognizant of this year? And if the pace of this program even exceeds your $600,000,000 expectation, is tax in any way a governor like you would consider having to push some sales into 2020? Just one qualification on that, Neil. As long as we can get the remaining Calgary office buildings done this year, then the tax will be I see. Yes, if the Calgary office moves into next year, then there could be some tax impact this year. Okay. Thank you. Thank you. There are no further questions at this time. Please proceed. Okay. Well, thanks again, everyone, for joining us on this call. We know it's a busy time of the year again. So we wish everybody a happy Friday and a great weekend. We'll talk soon. Bye bye. Ladies and gentlemen, this concludes your conference call today. We thank you for participating and ask that you please disconnect your lines.