Granite Real Estate Investment Trust (GRP.U) 2012 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the conference call of Granite Real Estate Incorporated. Speaking to you on the call this morning are Tom Heslip, Chief Executive Officer; and Mike Forsayeth, Chief Financial Officer.

Before we begin today's call, I'd like to remind you that statements made in the day's discussion may constitute forward-looking statements and that actual results could differ materially from any conclusion, forecast, or projection. These statements are based on certain material facts or assumptions; reflect management's current expectations; and are subject to known and unknown risks and uncertainties. These risks and uncertainties are discussed in the Company's material filed with the Canadian securities administrators and the US Securities and Exchange Commission from time to time, including the Risk Factors section of its Management's Discussion and Analysis for fiscal 2011 filed on March 9, 2012.

Readers are cautioned not to place undue reliance on any of these forward-looking statements. The Company undertakes no intention or obligation to update or revise any of these forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.

In addition, the remarks this morning may contain non-GAAP financial measures. Please refer to our Q2 2012 financial results and other materials filed with the Canadian securities administrators and the US Securities and Exchange Commission from time to time for additional relevant information.

I will now turn the call over to Tom Heslip.

Thank you, Jennifer, and good morning, everybody. Joining me on the call today are Mike Forsayeth, our CFO; Jennifer Tindale, our Executive Vice President and General Counsel; and John De Aragon, our Executive Vice President, Real Estate Investment.

I will be fairly brief this morning with my comments. This will give Mike Forsayeth time to take you through the details of our Q2 results and some important updates on other matters, and will leave us time for questions and answers.

Our second-quarter results were on budget and in line with our expectations. Through this period we continued to make progress on a number of fronts, and we continue to see evidence of strength and stability in our rental revenue profile and our overall earnings.

During this quarter we completed some important steps as we go forward in a positive and new direction. As you may know, we have relocated both the Austria and Canada offices away from the Magna tenanted properties or locations. Our Europe office is now centralized in Vienna, and our head office in Canada is now in Toronto. The Company's new name became official on June 13, and this is our first time reporting as Granite Real Estate.

Let me update you on two fronts -- first, our leasing activities; and secondly, the new business front. Regarding our leasing activities, I should say, as I have said in the past, that Granite cannot comment on the specifics of lease renewals or negotiations until such are fully completed and signed.

That being said, we can say that the past couple of months have been quite positive in terms of completing several leases, and there is much happening with regard to the 2012 and 2013 lease expiries, as well as several other leases and properties with longer-dated lease expirations. It has been a positive couple of months.

To this point, in 2012 we have now concluded lease renewals, expansions, and extensions on 11 properties totaling approximately 2 million square feet. These represent total annual lease payments of approximately CAD8.3 million, which is an overall increase of approximately CAD1.2 million in annual lease payments related to these 11 respective properties.

The new rents have now commenced or are scheduled to commence by early 2013, in conjunction with applicable project completions. The weighted average lease term for these leases is nine years.

Let me break them down -- the 11 leases I referred to. They can be summarized as follows. 4 which have 2012 expiries have now been renewed or extended. These total approximately 385,000 square feet and CAD1.3 million in ALP, out of approximately 730,000 square feet at CAD3.4 million in ALP related to a total of 7 Magna leases expiring in 2012.

Based on current discussions and activities, we have a positive outlook for completing the renewal or extension of the remaining 3 2012 Magna leases expiring. 4 leases with 2013 expiries and 1 with a 2014 expiry have been renewed, totaling approximately 773,000 square feet and representing approximately CAD2.5 million in annual lease payments.

And 2 leases on properties which have longer-dated lease expiries and for which we have recently completed or are undergoing expansions -- these total approximately 800,000 square feet and represent approximately CAD4.7 million in annual lease payments. These are the properties located in Clinton, Tennessee, and Heiligenstadt, Germany.

So as I've said in previous calls, given that the process for resolving multiple lease negotiations is a relatively new dynamic for Granite and the Magna groups, we're very encouraged by the fact that in a year such as this, when we have only 7 Magna leases expiring totaling approximately 730,000 square feet or approximately CAD3.4 million in annual lease payments, that we have already completed 11 leases for approximately 2 million square feet and annual rents of approximately CAD8.3 million. So these last two months have indeed allowed us to accomplish seven completions on important leases.

As to new business, the diversification growth in acquisitions, we are very actively reviewing opportunities in various markets, parts of Canada, and Europe; but in particular, a recent focus in selected US markets. Overall, we like the balance of quality, product volume, yield, and some of the potential strategic alliances that we're seeing in the US.

It's a fairly wide range of product, but with a focus on the more traditional industrial front and in primary and secondary markets. That being said, we're not giving guidance on new acquisitions other than to reaffirm for everyone that the strategic objectives for growth and diversification remain primary.

In summary, Q2 was a good quarter. There's much to be done, and as I've stated in recent meetings and presentations, our focus is on achieving results that demonstrate progress on all fronts. That is what is most important, and I think we're on track.

With that, I will turn it over to Mike, who will take you through our Q2 results.

Thanks, Tom. As Tom said, the results for the second quarter of 2012 reiterate the consistency and stability of our revenues and cash flows. The quarter was on plan, in line with our expectations, and not surprisingly, similar to Q1.

As in prior calls, I'll not be making any comments with respect to the results from discontinued operations, namely, the lands held for development and the Racing & Gaming business that was transferred out now over a year ago. That said, as you can appreciate, many elements and costs associated and related to that transaction certainly make certain year-over-year comparisons not relevant.

Q2, like Q1, was on track. As expected, we did incur some nonrecurring expenses in the quarter pertaining to the REIT conversion and the undertaking of detailed property reviews and assessments, including appraisals and environmentals on all of our 105 properties.

The total amount for these combined efforts in the quarter were CAD1.4 million pretax. And just before I get into the details of the quarter results, let me give you a brief update on the REIT conversion itself and other reporting initiatives that we have talked about in prior quarters.

As it pertains to the REIT, we continue to be proactively working with our advisers on the REIT conversion in each of our major jurisdictions, and we continue to see no change in our projected timeline of January 2013. As previously mentioned, the REIT conversion process will require a court-approved plan of arrangement and certain consents, including obtaining shareholder approval at a special meeting of shareholders.

This meeting is planned for mid- to late November of this year, and we expect to publicly announce this date in the coming weeks. Complete details of the conversion will be outlined in the forthcoming information circular, which is expected to be mailed out in October.

Secondly, this is the second quarter that our results are reported in Canadian dollars, but still under US GAAP. As previously mentioned, the only significant change on the face of the financial statements is in the Equity section on the balance sheet. There, and as described in more detail in a table in Note One, you'll see -- to the financial statements -- you'll see an increase in the stated value of the common shares of close to CAD600 million, with almost a corresponding offset in accumulated other comprehensive loss. This is because GAAP requires equity balances to be translated at the historical rate, which at the time was just under CAD1.40, and the Canadian dollar has certainly appreciated since then. Thirdly, we continue to evaluate converting our financial reporting to IFRS, and we are actively working on determining those steps necessary to implement it.

With that as some background, I'll turn to the second-quarter operating results of our business. First of all, currencies again played a role in our reported results. Relative to the first quarter, the average foreign exchange rate for the US dollar appreciated 1%, while the euro depreciated 1%. As compared to the same quarter a year ago, the US dollar has appreciated 4% against the Canadian dollar, while the euro has depreciated 7% against the Canadian dollar. I'll comment on the impact of foreign currencies for the balance of the year a little later in my comments.

On an as-reported basis, our quarterly net income was CAD18.7 million, and funds from operations or FFO was CAD29.4 million. That's CAD0.40 per share and CAD0.63 per share, respectively, and very consistent with Q1's performance.

As set out in our MD&A, our second-quarter G&A includes approximately CAD700,000 of REIT conversion advisory costs that really aren't representative of our run rate. Without those costs, our G&A in the quarter would be approximately CAD5.5 million, which are in line with our expectations, and we continue to target an annualized G&A run rate in the CAD21 million range.

We also incurred approximately CAD700,000 in appraisal and property-related assessment costs that are not representative of our run rate and are also partly incurred as a result of converting to a REIT. If you were to adjust our Q2 results for the after-tax impact of those additional G&A and property operating costs, our net income and FFO would increase approximately CAD0.02 a share.

Turning to the detailed income statement, revenue for the quarter increased by CAD600,000, or about 1% from the prior year. Contractual rent adjustments, revenue from completed projects, as well as renewals and releasing added CAD1.8 million to the rental revenue. These increases were partially offset by CAD1.2 million from the combined impact associated with the depreciated euro, and to a lesser extent, the non-cash related straight-line adjustment. With respect to property operating costs, the majority of these costs really relate to property reviews and the appraisal costs I referred to earlier.

G&A expenses, as I mentioned, were aligned with expectations. The quarter itself had some seasonal increases associated with our AGM, and we expect on a run rate basis, costs will reduce somewhat over the balance of the year.

Depreciation was up slightly due to recently completed expansions. With no debt other than our Canadian dollar-denominated debentures, our interest expense came in as expected at CAD4 million.

In addition, you'll note that we had over CAD600,000 of foreign exchange gains in the quarter. These gains are largely realized gains and are a result of some proactive steps taken to forward-buy Canadian dollars to hedge our expected cash outflows. These gains also mitigated the adverse impact of the recently-depreciated euro on our results.

Looking ahead to the balance of the year, in Note 14 to our Q2 financial statements, you'll see that we have 4 foreign exchange contracts outstanding to sell a total of EUR20 million to buy CAD25.8 million of Canadian dollars. The average rate of these contracts is 1.29. These were put in place to hedge a portion of our known Canadian dollar outflows, namely our dividends and debenture interest payment, and also serve to mitigate the weaker impact of the -- the impact of the weaker euro on our reported results for the balance of the year.

Our effective tax rate in the quarter was 21.4% and was higher than our expected run rate. The most significant factor impacting this quarter's effective tax rate was the decision in June by the Ontario provincial government to freeze previously-legislated tax reductions. As a result, we recognized a future tax expense of approximately CAD800,000 in the quarter related to the revaluation of our Canadian future tax liabilities. Excluding that future tax expense, our effective tax rate would've been a little over 18%, and more in line with our current annual run rate expectations of between 18% and 20%.

Also, looking at Q2 2011's tax provision, it is important to note that it includes the reversal of an almost CAD13 million tax liability associated with a corporate amalgamation that was set aside and canceled by the courts last year.

Turning to the results for the six months, it's almost as simple as Q2 times 2, so I'll keep my comments brief. On an as-reported basis, our quarterly net income was CAD37.3 million, and funds from operations were CAD58.8 million, at CAD0.79 per share and CAD1.25 per share, respectively.

As previously mentioned, given the impact of the transaction associated with the plan -- arrangement that was completed at the end of Q2 of last year and the large tax recovery, the overall results for the first half of 2012 are really not comparable to the same period in 2011, although you can certainly see it at the pretax level a significant improvement.

As set out in our MD&A, our G&A includes approximately CAD1.5 million of REIT conversion advisory costs and CAD300,000 of employee termination costs. Without these costs, our G&A in the first half would be about CAD10.9 million. We also incurred CAD1 million in appraisal and property-related costs, as I mentioned earlier, that are not representative of the run rate of our property and operating costs. If you were to adjust our results for the first six months for the after-tax impact of the additional G&A and property operating cost, our net income and FFO would increase approximately CAD0.06 per share.

In addition, and no surprise, currencies played -- impacted our results for the first six months when compared to last year. Relative to the first half of last year, the average FX rate for the US dollar appreciated 3%, while the euro depreciated 5%.

Revenue for the first half of the year increased by CAD2 million, or 2.2% from the prior year. Contractual rent adjustments, revenue from completed projects, and from renewals and releasing added CAD3.7 million. These increases were partially offset by CAD1.7 million associated with the impact of the depreciated euro, and to a lesser extent, the non-cash related straight-line adjustment. Our effective tax rate in the first half was 20.2%, again, influenced by the adverse decision in June by the Ontario provincial government.

Some additional financial metrics and matters I'd like to highlight include -- since the beginning of the year, our annualized lease payments at the end of the second quarter have increased CAD1.3 million. These positive increases of contractual rent adjustments and rents from projected -- from projects that have come on stream of almost CAD3 million, together with some appreciation of the US dollar, more than offset the impact of the euro.

In the quarter we've invested CAD8.8 million in capital expenditures for 5 projects to enhance our future revenue stream with Magna -- 4 in North America, and 1 in Europe. For the six months we've invested a total of CAD16 million across 9 of our properties.

We bought back almost 83,000 shares under our normal course issuer bid for CAD2.7 million. And at the end of the quarter, we had almost CAD60 million of cash in the bank. Overall, we're pleased with this quarter's results and the stability of the financial performance it demonstrates.

Lastly, and in closing, I'd like to thank all of our people, both certainly here in Canada and Austria, for their contributions and efforts that helped make this another successful quarter.

With that, I'll turn it back to Tom.

Well, thanks, Mike. I think we're ready to open it up for questions, if there are any.

(Operator Instructions). Mike Markidis, RBC Capital Markets.

Thank you and good morning, Tom and Mike. Tom, you certainly threw out a lot of numbers at the beginning of the call with respect to the leases that you've actually completed, so I was just hoping that we could actually maybe quickly run through some of those again.

If I understand you correctly, you're comparing to what you had at the beginning of the year when you're giving the numbers you gave, so you got 11 properties so far that have been renewed. And these are all with Magna?

Yes, they are.

Okay, that's about 2 million square feet. And you said there was an CAD8.3 million of ALP on these renewals, and that is a CAD1.2 million ALP increase?

Relative to those 11 properties.

Right. Okay. Now, that CAD1.2 million, does that include the impact of the incremental rent that you're getting from the expansion projects, the one in Clinton and then the one in Germany?

Yes.

Okay, so if we strip that out, what would the comparative ALP be?

Well, I can break that down. On the 2012s, roughly speaking, I mentioned 4 that have been renewed. They have been renewed at CAD1.3 million. That on those 4 is off of -- only down about CAD100,000.

Okay.

On the 4 leases that expire in 2013 and the 1 that was expiring in 2014, which by the way, is a single group, and that is why we were able to do it in that type of cluster -- one of the approaches we take with Magna -- on those 5, the rent in place prior to the renewals was overall CAD2.5 million, and the renewal was CAD2.5 million. So by and large, of the 9 we've done really in this quarter, signed in this quarter, we have been able to hold rents almost constant, and then the bump is coming from Tennessee, primarily.

That's very helpful, thanks. And excluding those two expansion and extension projects, have you had to give any -- on the completed leases you've done so far, have there been any inducements, like free rent periods or anything like that to speak of?

No free rent periods related to it. We have put some capital in. I don't want to give that number -- it's not a large amount of capital. We put some investment into the premises itself -- pavement work and some roof work.

Okay. And I guess that weighted average term then, that would be including those extensions as well, like Clinton, you got an extra 10 years. On the --

That, yes --

Sorry?

Clinton is the driver to the overall weight -- the generally term on the 12s and 13s is around a five-year term, consistent with the renewal. But the weighting -- because Clinton, and in fact, Heiligenstadt, are such large properties, of course, the weighting is favorable on the upside.

Okay. That's helpful. Maybe a couple of questions for Mike. Mike, on the FX, you noted that the positive impact of your hedging program, that runs through your FX gain and losses line, predominantly. So you've got CAD20 million of contracts set up. And does that hedge, basically, your exposure for the next quarter, the next two quarters, or how should we be thinking about it?

Well, there's two contracts for -- in the middle of September and two in December. So there is CAD10 million in September; CAD10 million in December.

Okay. And you certainly got a good rate there at 1.29, I think it was you said, relative to where we are today. When you look out to 2013 and even beyond that, have you given any thought -- are you more on the sidelines now given where the rates are and waiting for it to come back a little? Or do you expect that you will maybe adopt more of a -- for lack of a better term, a silent strategy, where you just decide to do a rolling program and hedge off a certain amount of exposure, no matter where the rate is on a rolling basis?

I think it is going to be a bit of a combination, Mike. Right now, we're sitting a little bit on the sidelines as we work through just the reconversion itself. That's impacting sort of, I'll say, the thinking in terms of how funds need to move around initially as it relates to that.

So right now it's sitting a little bit on the sidelines, but we'll look to be proactive. It is sort of, we had mentioned before -- long-term goal is to try and best match our balance sheet. And that remains the goal overall.

Okay. Now, within the existing portfolio of properties you have, I know you don't have an immediate use of capital, but have you guys been exploring at all the potential for getting mortgages, property-specific mortgages on the properties? And do you have a sense, of all the properties that you have, what percentage of those or what proportion of those would actually -- you'd be able to get a traditional mortgage on? Broadly speaking?

Well, I think the first answer, Mike, is we are exploring a number of different ways we can look at financing for growth and for existing assets. But most importantly is that the credit facilities we have in place put us in good standing.

So in terms of immediate action on mortgaging any current asset, no. In terms of the work Mike has done to put the credit facilities in and expansion the credit facilities, we're in a good position.

We are drilling down now, I think more specifically on looking at the overall portfolios -- which ones are the best candidates for mortgageability. But it's not immediate; it kind of fits in with what we've been working -- where I have described for all investors, the most important part the last several months and today is this the full strategy for each and every asset, and the full underwriting and strategic plan for each and every property.

And that ties in the work we're doing with Magna; the flexibility of the assets with different options. As we've said, there are assets we will consider doing things with Magna that could include swaps, sales and acquisitions of things they have, and mortgageability or financing.

So I don't want to say what percentage of it is mortgageable. We can say our valuation work and so on is continuing to show strength in the revenue stream, and typically that is a positive sign for the financeability of an asset, but nothing specific today.

Okay, thanks. And just one more quick housekeeping question for Mike before I turn it back.

Mike, the increase in the income tax expense and I realize that that was due to -- some of that was due to deferred taxes, it looks like the cash tax line actually increased about CAD1 million or maybe CAD900,000 sequentially. Would that be indicative of a better run rate going forward, or was there anything one-time of nature that was impacting that?

No, there is nothing of a one-time nature in there, Mike.

Okay. So if you take the CAD5 million, you could assume you're running at about CAD20 million annually, and maybe cut that down in half, with the potential to cut that down in half with the reconversion?

Certainly you can cut it down, as sort of we talked about, substantially. I don't know necessarily whether it's in half, but it will cut down substantially on the reconversion, with the primary piece coming out of Canada.

Okay. But no change in terms of your prior expectations in terms of the cash tax savings?

No, nothing.

Okay, that's great. Thanks very much, guys.

Sam Damiani, TD Securities.

Just to follow up on the tax side there, I think you've given out some specific guidance on where you see cash taxes going under the restructure next year. Could you just maybe clarify that and provide any update in that regard?

I think it is -- in speaking with Mike, the -- overall, we've got our -- as indicated, annually around that CAD20 million. It will be -- cut that down substantially. Whether it's half or less than half, but I would say it's not more than half at this stage.

Okay. And you're saying, most of that tax going forward as a REIT would be coming from jurisdictions outside of Canada, is that right?

The tax that we would ultimately pay would be jurisdictions outside of Canada, that's exactly right.

And which jurisdictions would be causing the bulk of that?

The most impact is Mexico, and to a lesser extent, in Austria.

Okay. And so those tax numbers we were just talking about, that is on a cash basis, is that correct? Will you be reporting future income tax, still? Or will you --?

Yes, we well. There may be future tax impacts in terms of the tax basis in each of the jurisdictions; they will be taxed on an accounting basis on the differences.

Right. So again, just focusing on the cash side of the tax picture here, CAD20 million run rate, call it, cutting that in half as much as in half.

At this stage, Sam, I'm not going to say it's more than half. It might be somewhere between less than half and half.

All right, that's great. I'll just move on. Those lease renewals that you've accomplished, have they been reflected in the property stat sheet for the quarter? Or will those be reflected next quarter?

They would be in the next quarter.

Next quarter. And what is the property in Germany that was recently expanded?

Heiligenstadt.

Okay. And going forward, you talked about where you're looking for acquisitions. What parts of Europe meet the smell test from a tax perspective going forward? Just a little surprised to hear that you're looking over there.

Well, we are -- I would say first and foremost is that the Company wants to take advantage of some of the strengths it has, and one of those is that we do have pretty significant operations in Europe and in North America, and we're structured to look at both.

So Europe we looked at a little more cautiously, for obvious reasons, and opportunistically. So from that front, we do want to -- we're not blacklining it.

That being said, where we were looking is in Germany, in the UK, and candidly, a little bit in France. We are certainly aware of the exchange side and the tax side, but we're also seeing some things that, based on the quality of product and tenancy and the yield, you can make sense of looking at it a little more seriously.

That being said, we're not pulling the trigger on anything there right now. It is not Eastern Europe. It is at this stage, centralized in Germany, France, and to some extent, the UK. But we are looking around.

Okay. And so on the topic of financing the growth, I think you've talked about a CAD400 million capacity for growth, given the balance sheet today, without having to raise equity. How would that be financed? I know you've got a credit facility to finance a portion of it, but -- .

Well, I think we really look at it in a simple way. You have got our credit facilities that are in place and our lines that allow us to act more immediately. And then primarily on something we would acquire would be mortgage debt on that acquisition. So you're combining the facility in place with say, theoretically, 50% mortgage on what we might acquire.

So we look at our lines in place and the expansion of those lines as there to deal more immediate with our existing assets and, I guess for lack of a better way, the equity component of an acquisition, and that acquisition, potentially, then, putting mortgage debt on it.

So it sounds like you are thinking that the lines could be expanded from where they are today.

We look at that, yes.

And so beyond CAD400 million, how would, let's say, the next CAD400 million be financed?

Well, it would have to be -- let me just say, we're cautious on discussing that, because we do have debentures in place, and debenture -- we're working within those covenants. So the figures we referred to, CAD300 million to CAD400 million, are within the bounds of the existing debentures.

All right. Okay. All right. The German expansion there, what was the cost of that project? And so what was the yield based on the increased ALP?

The Heiligenstadt project, the increased cost on that was, if I recall --

I think it was CAD4.8 million.

CAD4.8 million. The existing facility is 236,000 square feet, and we expanded it by roughly 50,000 square feet. We took the lease out from 2018 out to 2022. And the increment on rent on that was about CAD350,000. So we did a little over -- around an 8.5 cap on the CAD4 million.

Okay.

8 cap.

8 cap. And what sort of money -- what sort of improvements does that CAD4.8 million -- like, are you doing base building work there? Or are you investing in any kind of specialized equipment for -- on Magna's behalf?

Our approach is that the funds we put in is building-related. And it is the same for the tenants. What the tenant doesn't want to do is expand our building at their cost, enhance our building at their cost, where it's an improvement to the facility. So our money is going to the creation of space and perhaps enhancement of access, egress, other components of the actual physical space. Their own capital would go into equipment and the internal side.

So we look at all projects, not just on how much we spend and the yield we get, but on making it a better facility, or for leaving us, say, at the end of the day, with real estate, not equipment.

Okay, that's helpful.

All of that, really, in a nutshell is to say the money went into the physical expansion.

And the properties under development -- that pipeline has expanded since the first quarter, which is great to see. Can you maybe identify some of the larger projects? Are there -- by city or by name, and what the -- ?

Well, as you know, Clinton is by far the largest of those. Clinton is roughly a CAD17 million project overall. So it is capped in the most. Once you put -- scale back Clinton, and now that Heiligenstadt is done, you are dealing with a series of capital upgrades. The new structural components, that might be our responsibility -- say, for example, paving it's a big thing. Some roof work is a big thing. And those are done in conjunction with lease renewals or extensions. So once you strip out right now the Clinton project, you're really talking about capital improvement projects, but smaller in scale.

So the remaining, let's say, 8 projects, most of them are not expansions?

They are not expansions.

Okay. Just one small thing. I noticed on the property stat sheet that the undepreciated book value in the Canadian segment went down a bit. Just wondering if there is an explanation there?

No, there's nothing unusual to take away from that, Sam.

Okay. Thank you.

Thank you. And I'm showing that there are no further questions from the phone lines at this time. I'd like to turn the call back to you, gentlemen.

Well, that's it from our end. Hope we keep moving along, and we thank everybody today.

Thank you. Ladies and gentlemen, that does conclude the conference call for today. We thank you all for your participation, and we ask that you please disconnect your lines. Thank you and have a good day.