Granite Real Estate Investment Trust (GRP.U) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the MI Developments third-quarter 2007 conference call. At this time, all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Friday, November 9, 2007, at 10:30 AM Eastern Time.

I will now turn the conference over to Mr. John Simonetti, Chief Executive Officer. Please go ahead, sir.

Thank you, operator, and good morning, everyone. We appreciate you joining us today to discuss MID's 2007 third-quarter results.

With me today is MID's Chief Financial Officer, Richard Smith. I'm going to ask Richard to take you through our results later on in the call, and after that we will open the lines for your questions. Other members of executive management are also in attendance, and if necessary, I may ask them to participate during the Q&A session as well.

Our Board of Directors met yesterday and approved our financial results for the three and nine months ended September 30, 2007. The Board declared a dividend of $0.15 per share for the third quarter, payable on or about December 15 to shareholders of record at the close of business on November 30, 2007. This morning, we issued a press release with our third-quarter results. A copy of the press release is posted on our website at www.midevelopments.com.

I also remind our participants that this conference call may include forward-looking statements within the meaning of applicable securities legislation. For a description of the risks, uncertainties, material facts and assumptions associated with forward-looking statements, please refer to this morning's press release, which includes a discussion of these matters at the end of the text. The press release also includes a reconciliation of the net income of our real estate business to funds from operations.

I'm going to begin with some comments on our core real estate business, which posted strong results in the third quarter. FFO per share came in at $0.77, and our annual rents, as calculated on the last day of the quarter, were a record high of $173 million.

Looking behind the numbers, the primary driver behind the strong results was foreign exchange. Approximately three-quarters of our rents are collected in either euros or Canadian dollars, and so the continued weakening of the US dollar has had a fairly significant positive impact on the business and overall financial results.

Now, having said this, the other core operating drivers of our real estate business continued to fall short compared to what we've historically achieved. There is very little to report in terms of new projects with our main customer, Magna International. Although we are expecting some expansion work to surface over the next couple of quarters, our current level of business has dropped off significantly from the amount we've received and become accustomed to receiving prior to our spinoff in 2003 and for a couple of years after that time.

In prior conference calls, I've been upfront and candid on the reasons behind this slowdown. Lately, I can't help but be concerned that this slowdown may translate into a more permanent reduction in the quantum of business we'll receive from Magna. As the slowdown has continued and the potential for a more permanent reduction has become more and more real, I know that we -- and when I say we, I mean our management team and the Board -- have attempted to develop solutions that are intended to re-establish the growth in our core rental portfolio. But as much as we try to find solutions -- and we continue to do so -- we haven't been able to arrive at a consensus amongst the various stakeholders that would put the future direction of the Company back on track as Magna's primary supplier of factories and offices.

So the question is, where do we go from here? Although our Magna work has slowed down significantly, we recognize that we still need to focus on creating value for shareholders and grow the business. With our strong balance sheet and stable, long-term cash flows, we certainly have the financial means to do so.

So more recently, as we continued to review the strategic direction of our company, we have also put our financial resources to work. Aside from finally being able to execute on our stock buyback program, we have also started to diversify our portfolio by acquiring lands suited for development from our subsidiary, Magna Entertainment. Although MEC has some obvious financial and operating challenges, it also has other obvious traits, including that it has an abundance of land with excellent development potential. Many of the MEC properties are located in great urban markets, and given that we already know these properties fairly well, we continue to look at the MEC lands as attractive candidates for us to buy.

So far this year, we've spent a total of $90 million to purchase four parcels of MEC land, which we intend to develop for residential or mixed-use purposes. In addition, we are currently evaluating certain other MEC properties, including those adjacent to MEC's Gulfstream facility near Miami as well as MEC's 50% joint venture interest in the mixed-use development adjacent to Gulfstream and the planned mixed-use development adjacent to MEC's Santa Anita Park near Los Angeles. If we proceed to buy all of these assets, these would certainly be a substantial investment for us.

Now, stepping back for a moment, I want to point out that at the current share price, MEC's total market capitalization is approximately $200 million. I wanted to point this out because it's interesting to note that the MEC development opportunities we are currently evaluating in the aggregate could have a value that is close to this. Now, given that, in my view, the assets that we are considering to purchase represent only a relatively small portion of MEC's underlying land value explains why we continue to view our MEC investment as having significant potential long-term value, assuming MEC can successfully improve its operations and strengthen its balance sheet.

Which leads me to my final discussion point, and that is the MEC bridge loan we announced during the third quarter in connection with MEC's debt elimination plan. At the end of the (technical difficulty) MEC's total debt was $560 million, including $200 million own to us. MEC believes that it needs to raise $600 million to $700 million through a combination of asset sales and an equity raise in order to pay off all its debt and fund its operations through the end of 2008.

Our management team and the MID Special Committee of Independent Directors, with the assistance of our respective outside advisors, carefully considered MEC's debt elimination plan, including a detailed review of the assets that MEC plans to sell. Following that review and after considering, among other things, the recommendations from management and the Special Committee, the MID Board decided that it was in the best interests of MID to provide MEC with the bridge loan. Ultimately, given the amount of debt we have owing to us from MEC and the value of our MEC equity investment, we truly have a lot at stake, and therefore a very strong interest in MEC successfully achieving its debt elimination goals. Providing the bridge loan was intended to give MEC time to proceed with its planned asset sales in a prudent and orderly manner, with the beneficiaries being all MEC shareholders, including MID.

This now ends my formal comments, and I will now turn the call over to Richard Smith. Richard?

Thanks, John, and good morning, everyone. Before I begin, I'd like to remind listeners that my comments this morning will focus only on the results of MID's real estate business and, unless otherwise noted, all amounts in today's presentation are expressed in US dollars.

Looking first at our annualized lease payments or ALP, we saw an increase of 9% from the beginning of the year, giving us ALP of $173.1 million at the end of the third quarter. On a sequential basis, ALP increased by $8.1 million from $165 million at the end of the second quarter. At September 30th, approximately 75% of our ALP was denominated in currencies other than the US dollar, with euro and Canadian dollar rental payments representing 40% and 34% of total ALP, respectively. As a result, changes in foreign exchange rates had the most significant impact on ALP, adding $7.1 million due to the continued weakening of the US dollar against the Canadian dollar and the euro. In addition, projects coming onstream contributed $1 million to ALP in the quarter.

Our funds from operations or FFO for the third quarter was $37.3 million or $0.77 per share, compared to $35 million or $0.72 per share in the prior year. Please note, however, that the current and prior-year amounts include various unusual items. In the third quarter of 2007, our cash taxes were positively impacted by a $1.1 million tax recovery, due to a favorable tax reassessment in relation to land sold in the prior year. In addition, the results for the third quarter of 2006 included $2.4 million of advisory and other costs incurred in connection with the Company's evaluation of certain transactions that, ultimately, were not undertaken. Excluding the effect of these unusual items, our FFO for the third quarter was $36.2 million or $0.75 per share, compared to $36.7 million or $0.76 per share in the prior year.

When comparing our FFO on a sequential basis, please note that we incurred a number of unusual items in the second quarter of 2007, including $2.1 million of advisory and other costs incurred in relation to our continuing assessment of our relationship with MEC and a $2 million charge relating to our decision to contribute land located in Simmesport, Louisiana to a not-for-profit organization in support of Hurricane Katrina redevelopment efforts, which are being spearheaded by Magna International.

Excluding the effect of unusual items, FFO for the quarter increased sequentially by $1.5 million or 4% from $34.7 million or $0.72 per share in the second quarter of 2007. Higher revenues and lower G&A expenses increased FFO by $1.2 million and $500,000, respectively. These increases were partially offset by an increase in cash taxes of approximately $200,000. In terms of the $1.2 million increase in revenues during the quarter, rental revenues contributed $900,000, driven primarily by foreign exchange, while interest and other income from MEC contributed $300,000 to the overall increase.

In terms of our cash taxes, and excluding the effect of the unusual items previously discussed and real estate disposal gains, cash tax rate for the third quarter was approximately 16%, which is consistent with the second quarter 2007. In terms of our overall tax provision, our income tax expense for the third quarter of 2007 was also positively impacted by a $1.6 million future tax recovery from the reduction of the future tax rates in Germany, Canada and the United Kingdom. Excluding the effect of these rate changes and the $1.1 million cash tax recovery discussed earlier, we incurred a total tax provision of $6 million during the quarter, which represents an effective tax rate of 19.5%.

Excluding unusual items, the total tax provision for the third quarter of 2006 was $5.1 million, representing an effective tax rate of 16.7%. This 2.8% increase in the effective tax rate is primarily due to changes in the overall mix of the Company's taxable earnings in the different countries in which we operate and a legislative tax change affecting one of our foreign operations.

Turning now to the balance sheet, our cash balance at the end of September was $158.2 million, representing an increase of $10.3 million from the prior quarter. Sources of cash during the third quarter amounted to $47.3 million, including $40 million of cash from operations, $2.1 million of loan repayments from MEC, $900,000 of proceeds on the disposal of a real estate property and $4.3 million due to changes in exchange rates on our cash balances. Cash used during the third quarter amounted to $37 million, including $11.8 million used to repurchase shares under our normal-course issuer bid, $7.1 million of capital expenditures, $10.8 million of advances net of related fees under the loan facilities to MEC and $7.3 million of dividend payments.

Two expansion projects came onstream during the third quarter, representing 28,000 square feet of leasable area and contributing $1 million to ALP. At the end of the quarter, we were working on two expansion projects for Magna, one in Canada and one in Austria, representing 39,000 square feet of leasable area with a budgeted cost of $5.7 million, of which $5.2 million had been incurred at September 30th. We anticipate that when these properties come onstream, they will add approximately $500,000 to ALP.

As previously mentioned, we advanced $10.8 million and received $2.1 million of principal repayments under the loan facilities to MEC, bringing the total amount outstanding from MEC at September 30th to $209.7 million. This amount is net of $2.2 million of unamortized arrangement fees relating to the MEC bridge loan.

I'm pleased to say that during the quarter, we repurchased 485,700 Class A subordinate voting shares under the Company's normal-course issuer bid at a total cost of $15.4 million, of which $3.6 million was paid subsequent to September 30th. Subsequent to the quarter end, the Company repurchased an additional 340,400 shares at a total cost of $11.4 million, bringing the total number of shares repurchased under the Company's two successive normal-course issuer bids to 826,100 shares at an aggregate cost of $26.8 million. These repurchases were undertaken at a weighted-average price per share of C$32.91. Depending on future price movements and other factors, we believe that the Company's Class A subordinate voting shares may, from time to time, represent an attractive investment alternative for MID and a desirable use of any available funds.

This concludes my formal remarks. Operator, we will now open the lines for questions.

(OPERATOR INSTRUCTIONS). Sam Damiani, TD Newcrest.

Is there any update on the plant rationalizations from Magna?

In terms of plant rationalizations, there's really a couple more that came up in the quarter. We're going to work with them, see what we can do to get out of them. But I'm not sure if there's going to be more coming forward. We haven't heard anything from Magna directly, but they had their conference call earlier this week and they did make a point in saying that there could be a few plants in North America, particularly here in the GTA area, that they may rationalize and move operations elsewhere, specifically Mexico. But they haven't come back to us specifically on what their plans are with facilities that they have leased from us. But we did receive two other notices on plants in the quarter.

How big are these plants? What are the rents?

One is here in the Toronto area. It's about 260 -- actually, this one was just some raw land they had leased from us which they are not going to renew the lease. That's really -- the annual lease payment on that is somewhere around $200,000 a year. Then there's a facility out in Michigan which is a [mares] facility. That plant is roughly 200,000 square feet and it's about $0.5 million of rent.

The leases on those go for a while, do they?

They actually do. They go probably about another 10 years, and they are still paying us rent right now. So we haven't really sat down with them and decided what to do here, but the leases do run for another 10 years.

How many more plants do you figure -- obviously, you can't say for sure. But just based on what they are saying publicly, what range of number of incremental plants could you envision being rationalized within the portfolio?

I wish I could be definitive on that, but I really can't. Like I said, I haven't really sat down with Magna; we haven't sat down with them to really determine which are the plants involved. So I don't want to take a guess on that.

There's no news on the other plants that were previously identified and progress in terms of coming to resolutions on those?

Well, since Magna announced their plant restructuring, I think there are basically six of the plants we've already dealt with. Either we've sold them at a profit or we've managed to sublease them to third-party tenants or, in one particular case, which is a facility we have over in the UK, we're sitting on a pretty large gain there, and we are looking to accommodate Magna in their moving plans so that they can move out and we can move ahead with our rezoning of the property to residential.

So we've been able to deal with these plant rationalizations, I think, in an effective way that's a win-win for both sides. Hopefully, we can continue to do that with the ones we have left.

I think there were six unresolved last quarter?

Last quarter, you are right; there were six.

Is there anything new to report on that front?

Well, that's what I said. We got two more this quarter, and on those that are left, I think there's one we're looking to sublease to a third party, and I think we're going to get that one done shortly. We are still working on the other ones.

Just over to your earlier comments about the three additional projects that you are looking at from MEC, the adjacent lands at Gulfstream, the 50% interest in mixed-use project at Gulfstream and the planned mixed-use project at Santa Anita, you said that the value of that could be roughly $200 million. I think that's what you said. Is that right?

I think that's right. I think that, based on the comments in my formal comments, I think you're right.

Does that include any in-place debt on these assets that you would be assuming? Is it a just cash contribution required to --?

No, we would not be assuming any debt, although I will point out, if we buy certain assets, the proceeds from those assets, a good majority of them, would probably have to come back to us first to repay the bridge loan, if not part of the project financings.

At what stage is your consideration on these three projects? Is it something you could --?

Management is still doing our work on these properties. We do take a thorough review on the development potential and what the potential returns are and the timelines, and we're doing that analysis. Once we're comfortable, we think it makes sense, then at that stage, we're obligated to take that thinking through to our Special Committee and take them through our analysis and they'll go through it -- we will go through the process at that point. It's still with management right now, and we're just looking at the properties and pushing numbers.

Could you just give us a very brief overview of each of those projects and sort of what they're all about, briefly?

I don't want to get into specific details in the quantum of retail and/or residential. The one at Gulfstream is public knowledge. I think there's about 750,000 square feet of retail that could go on that property, and about 150 condo units, residential -- I'm sorry, 1,500 condo units that could go on that facility.

Then -- sorry, John -- another 140,000 of office space as well.

That's right. So that's public knowledge. I'm not sure the one in Caruso is public knowledge, so I'm going to defer on that one.

When will you be off blackout on the normal course? I guess, what, Tuesday of next week?

Well, assuming there's nothing else going on -- I'm looking at Richard Crofts, who is sitting next to me, our General Counsel. If he gives us the green light, then we should be out of blackout next Tuesday. But again, Richard is a fairly conservative guy, so we'll have to wait and see.

These deliberations on these three projects at MEC -- would that represent means for a blackout?

In my view, I think if we're looking to buy these projects -- this is just my view; again, I defer to counsel. But my view is it may not, because we've always stated our intentions to buy them. But again, I'll have to wait and see what counsel advises us in the next couple of days.

Does Richard Crofts have a comment on that?

I think John's comment is correct. We'll work through it in the next few days and then come to a determination.

But your expectation is, not likely to cause a problem?

Sam, I love the way you ask questions. We hope not. We hope not. We'll know internally here early next week.

(OPERATOR INSTRUCTIONS). Mr. Damiani, TD Newcrest.

You mentioned two expansion projects. I'm not sure if you were mentioning the same things that are underway as we speak, or is there two more new ones that are about to be started shortly?

Well, the expansions we have ongoing at the end of the quarter -- I think they were already started in the previous quarter. But what I said in my comments is I think there could be some more expansion projects coming up in the next couple of quarters. We're always in dialogue with Magna when it comes to expansion work. They have no alternative but to turn to us on those properties. So hopefully we'll get a little bit more to announce in the next quarter or so.

How big would those be? Kind of the same size as what you've got now, the $5 million, $6 million?

Once we get all the final details, we will let everybody know. But I really don't want to make a comment on that right now.

You talked about where do we go from here, given the slowdown in business from Magna. I guess, two questions on that. You are fearful that it's going to become permanent. Why would you say that?

Why would I say that? I think there's two reasons. The first one, in my mind, is the continued ongoing uncertainty, particularly with the ongoing lawsuit, which hopefully gets resolved in January, the ongoing lawsuit with Greenlight, which has definitely impacted our relationship with Magna. But more so, it's now very obvious to me that as Magna continues to restructure its manufacturing footprint, they clearly require significantly more flexibility than I think our lease arrangements offers them today.

Having said this, I think unless we can arrive at a mutually agreeable arrangement going forward between us and Magna, in terms of how we deal with these facilities and how we would deal with new facilities, I believe that Magna may decide to keep most if not all of its greenfield projects in-house, particularly when it comes to its key facilities.

So I think it's two points. I think what the ongoing uncertainty has magnified is the flexibility Magna really needs to run its business. The automotive business is highly competitive. You've constantly got to fine-tune your business and move things around, and Magna has always been able to do that at a very, very fast pace without a lot of administrivia. Being there for 10 years, that's one of the keys to their success -- push the decision-making down to the plants. When decisions are made, you move fast. When you lose that flexibility, you've got to ask what it does to them being competitive overall in that industry.

So I think we really need to sit down and assess what we can do, we being MID, what we can do to help them re-establish that flexibility, I think, if we want to get more business going forward. I think that's clear, and that's certainly something we discussed as a management team. That's something we discussed as a Board, at the Board level. That's extremely important for Magna, and we recognize that. So we're going to have to do some work there.

That makes sense. Where do you go from here, then, given that that kind of is a sort of dying business for you, if you will? You've got these MEC assets that you could buy, and they are obviously a meaningful one-time investment. But beyond that, isn't it kind of pretty important to think about where to go from here? Not just maybe next quarter in terms of buying these, but like you've got so much cash flow coming in and such an underleveraged balance sheet that there's got to be something much bigger beyond these MEC projects and anything in the future that MEC might offer. What else is there that MID is considering doing or becoming?

That's a very good question. We've had some good discussion at the Board level. We had a Board meeting yesterday, and we had very good discussion at the Board level precisely to that question. I'm not going to give any details of that discussion.

But certainly, we've got our annual planning meetings coming up, and the management team here is going to sit down and decide where do we focus and what businesses we're going to go after. Industrial is obviously our expertise. We're going to slowly develop kind of a second expertise as we develop these MEC facilities or partner up to develop these MEC facilities. You are right; we've got a great balance sheet, some great cash flow, and we're going to have to decide where we put that in place to grow our business.

Certainly, we can always use some of that cash flow to continue to buy back stock. Obviously, I've heard from a number of shareholders who think that's a great investment. We agree; that's why we bought back some stock.

But running a business is more than just buying back your stock, and we're going to take some time out here to really assess where we go forward as a company. Maybe we will have something to report in the next couple of quarters. But you raise the same questions we're raising in-house.

May I ask where Frank Stronach's head is at, in terms of where he thinks MID should go in the future?

The philosophy Frank has always instilled at Magna is you put the right guys in charge, and they are empowered to grow the business. That's how we get comped. The more we grow the business, the more we grow the pretax, the more we get paid, which is an incentive for us.

So from Frank's point of view and, I think, the rest of the Board, grow the business, grow it prudently. I don't think he's got any specific area where he thinks we should be focusing. I think that's a matter of management to decide and go to the Board and get their views on that.

But having said that, I'm not giving up on Magna. Certainly, that has been our primary growth driver in the past. But we'll just have to wait and see where we end up with this.

The normal course, I think, was renewed a month or so ago. How much room is left on this normal course? I think it expires October of next year? Is that right?

It's just slightly more than $2.5 million. We acquired about 24,000 shares under the second normal-course issuer bid, and it was for, I believe, just slightly more than $2.5 million.

Early October of next year? Is that right?

Yes, October 7, 2008.

Himalaya Jain, Scotia Capital.

Just on those potential MEC projects that you're looking at, what would be the hurdle rate as far as return goes for you to proceed with those or pro forma cap rate?

We're not going to get into specifics on what the pro forma cap rates or cash and cost returns are going to be on these projects. But from our point of view, when we look at these MEC developments, it has got to make sense from us. From an IRR perspective, these are obviously higher risk than doing straight industrial for Magna. We're looking for IRRs in the mid to upper teens, at a minimum, to go forward.

So from MID's perspective in the deliberations as to whether to proceed with these or not, is it more or less an IRR type of valuation? Or does the fact that you buying these assets from MEC and helping their balance sheet out also factor into the decision to proceed with these?

I think, when we have bought assets from MEC, we look at it first and foremost strictly from a development standpoint and does that make sense for us, and what returns we can get from those properties. That's how we look at those.

To the extent -- you are obviously putting cash -- cash is transferred to MEC as we buy these assets. But that's not necessarily how we look at it. At the end of the day, we've got to be able to demonstrate that we're going to have appropriate returns on these developments, and that's strictly how we talk about those developments and we take these ideas forward to the Special Committee.

In the quarter, in the fee and interest income line from MEC -- what was the breakdown of that number between interest and the fee amount?

The fee in the quarter was $150,000 of that total number. The bridge loan was approved -- announced on September 13th and expires on May 31st. So the arrangement fee of $2.4 million is being amortized accordingly.

Gentlemen, there are no further questions at this time. Please continue.

Well, I'd like to extend a personal thanks to Sam for asking all those questions. But no, they were good questions, we had some good dialogue and I appreciate that.

But nevertheless, thanks for everyone participating on this third-quarter call. I guess we don't get to speak to you until way in March, when we do our fourth quarter. So until then, over and out. Thanks.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.