Granite Real Estate Investment Trust (GRP.U) 2013 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the conference call for Granite REIT. Speaking to you on this call today is Tom Heslip, Chief Executive Officer, and Mike Forsayeth, Chief Financial Officer.

Before we begin today's call, I would like to remind you that statements made in today'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 annual information form for 2012, filed on March 5, 2013. 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 include financial terms and measures that do not have a standardized meaning under International Financial Reporting Standards. Please refer to the Q2 2013 condensed combined financial results for Granite Real Estate Investment Trust and Granite REIT, and other materials filed with the Canadian Securities Administrators and US Securities and Exchange Commission from time to time for additional relevant information.

During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded Thursday, August 8, 2013.

And I would now like to turn the call over to Tom Heslip. Please go ahead.

Thank you, and good morning, everybody. Joining me on the call today are Mike Forsayeth, our CFO, as mentioned, Jennifer Tindale, our AVP and General Counsel, John DeAragon, our EVP Real Estate Investment, and Lorne Kumer, our EVP Real Estate Portfolio and Asset Management.

With the reporting of our second quarter results, Granite has reached the halfway point of fiscal 2013, and it warrants taking a measure of where we stand and where we are headed in terms of our strategic plan, in particular two key components of that plan -- the first, to optimize our relationship with Magna, and second, to grow and diversify into newer age, high quality properties, a more diversified tenant base, all through acquisitions as well as noncore asset sales, new development and the effective deployment of our advantageous balance sheet. This plan entails all activities that one would associate with building a strong, well-positioned, long-term oriented real estate company.

Yes, Granite is structured as a real estate investment trust for all the beneficial reasons that come with a REIT structure, yet we view our business as that of building a true value-oriented real estate company. This means balanced consideration and resource allocation that is given to the renewal of leases, acquisitions on an international level of well-located, high-caliber properties with strong tenants and maximum releasability qualities, selective new development in high-demand markets, timely important sales of noncore, non-tax-efficient properties and through effective asset management, the repositioning of older or vacated properties. Executed properly, these activities create a successful real estate company -- in our case, a strong REIT.

Q2 for Granite not only resulted in successful outcome on those items we reported on in terms of financial performance, acquisitions and lease renewals, but it was a quarter marked by a series of events and activities that bode well for the remaining two quarters of 2013. It was a quarter where we built great momentum, and we feel we will execute on that in the months ahead.

Of the 2013 Magna lease expiries, which totaled approximately 5.4 million square feet, we have now renewed leases with Magna totaling 2.25 million square feet. Equally important, discussions with Magna are progressing on the majority of the remaining properties, with expected results in the remaining two quarters of this year.

Importantly also is that of approximately seven properties Magna is to vacate, we are in conditional contracts or discussions and negotiations with prospective buyers and-or prospective new tenants on several of these properties, and we will keep focus on striving for the best outcome on all of these properties.

In terms of growth and diversification, the halfway point of 2013 demonstrates we are on track and making progress. With the expected closing of the Westchester, Cincinnati, Ohio, property within the next couple of days now, we will have acquired over 1.5 million square feet of new age, state-of-the-art logistics distribution warehouses. This represents a total of approximately CAD80 million in income-producing properties acquired thus far this year, with a go-forward annualized rental income of nearly CAD6 million.

When including the new development sites we have acquired in Louisville, Kentucky, and in Pennsylvania, total acquisitions exceed CAD100 million thus far. And with the commencement of the construction of the Louisville building just a couple of weeks ago on July 24th, in a region with less than 4% vacancy rate, we have an additional 624,000 square feet in our pipeline in a high-demand rental market.

As I mentioned, much of what was put into action in Q2 and subsequent bodes well for the remainder of the year and represents what I will refer to today as Granite's pipeline. This means prospective activities in all four pipeline categories -- acquisitions, sales, leasing and new development. Most importantly, and I stress, this is not a conceptual pipeline, but, in fact, multiple activities that are under way.

However, given that there remain some uncertainties, we are not at liberty to disclose more detail other than to state that our overall pipeline, in particular near-term acquisition pipeline, is material and robust.

It has been a positive half year for Granite, but there still is much work to do. I believe that all the facets of Granite are operating at the best level they have been since we became Granite REIT, barely eight months ago.

Those are my comments for now. I'm going to hand it over to Mike Forsayeth to take you through our Q2 results.

Thanks, Tom. As Tom said, we had another solid operating quarter, and save for one tax item, it'll actually be a welcome change not to have to talk to you about plans of arrangement, REIT conversions, transitioning to IFRS or changing reporting currencies, but, rather, just our real estate business.

So with that as an introduction, I'll turn directly to our results for the second quarter and the first half of 2013.

Overall for the quarter and the half, our top line benefited from contractual rent increases, favorable exchange rates and our recent acquisitions. Much of this benefit flowed to the bottom line, as we leveraged both our REIT structure and our G&A platform, which is largely denominated in Canadian dollars.

Here are some of the specific highlights. On a reported basis, our quarterly net income was CAD43.4 million, CAD0.93 per unit, and compares with CAD41.2 million, or CAD0.88, for the second quarter of 2012.

There is one tax item in the quarter that has no impact on our reported net income, but does impact our reported funds from operations calculation. Our second quarter's current tax provision includes a net withholding tax payment of CAD4.2 million, largely related to the repatriation of prior years' earnings from foreign operations. This repatriation is associated with certain planned internal reorganizations undertaken post the REIT conversion.

These withholding taxes have been previously charged as a deferred tax expense in the income statement in the year the income was earned. Accordingly, this CAD4.2 million payment, which now runs through the current tax expense, was offset by the reversal of the deferred tax accrual of prior years, the net result being there's no impact on the total tax expense or the net income for the year.

However, recognizing that current taxes are included in the calculation of FFO and that we do not expect an earnings repatriation of this magnitude in the future, we've added this CAD4.2 million net payment to FFO to arrive at a comparable number to prior periods. After adjusting for this planned withholding tax payment, the current tax expense for the quarter relating to the earnings of 2013 would be CAD1.8 million and is consistent with our expectations and with the first quarter.

Looking at our comparable FFO for the second quarter, it was CAD35.5 million, or CAD0.76 per unit, up CAD0.14 when compared to the second quarter of 2012. This 22% increase in FFO is largely due to the increase in rental revenue of CAD4 million and lower current income taxes of CAD3.5 million as a result of becoming a REIT. These increases were partially offset by approximately CAD700,000 of increased interest costs and reduced net foreign exchange gains of approximately CAD500,000. It's also CAD0.03 higher than the FFO we reported for Q1 back in May.

Some of the significant items of note when reviewing our net income and FFO and comparing them to the second quarter of 2012 are as follows. From a revenue perspective, the increased revenue over the comparable quarter last year was mainly attributed to CAD1.5 million of contractual rent increases, mostly as a result of CPI increases related to our Austrian properties. CAD1.3 million of the increase related to acquisitions that we've completed, and there was CAD800,000 from favorable foreign exchange rates, and we had CAD600,000 from various completed projects that are now on-stream. The net impact of renewals, vacancies and straight-line adjustments were not significant.

Excluding those operating costs recoverable from tenants of approximately CAD300,000, our property operating costs decreased in the second quarter of 2013, mainly as a result of lower appraisal and environmental review costs. Our G&A for the quarter was CAD6.1 million, slightly lower than a year ago, and both years included similar levels of REIT and reorganization costs in the CAD600,000 to CAD700,000 range.

Our net interest expense for the quarter was CAD4.7 million, and relative to last year, it was CAD700,000 higher due to added interest costs associated with the borrowings for the new properties acquired.

There were fair value gains of CAD10.9 million before tax on our investment properties, largely attributed to changes in the leasing assumptions and projected cash flows and, to a lesser extent, discount and terminal cap rate compression.

Also in the quarter, we had almost CAD400,000 in acquisition transaction costs and just over CAD640,000 of net unrealized losses on our financial instruments due to our out-of-the-money foreign exchange contracts, largely as a result of the stronger euro and US dollar on June 30th.

On a year-to-date basis, given the impact of our REIT conversion on our reported results, our net income for the six months ended June 30, 2013, is really not comparable to the prior year. However, meaningful comparisons can be made using FFO as the metric. Our comparable FFO for the first half of 2013 was CAD69.5 million, or CAD1.48 per unit, up CAD10.8 million, or CAD0.23 per unit, from the CAD58.7 million, or CAD1.25, reported for the first six months of 2012.

The underlying reasons for this 18% improvement are consistent with the themes I outlined for our Q2 performance. We had higher revenue driven by contractual rent adjustments, completed projects now on stream, acquisitions and favorable exchange rates. We had lower current income taxes as a result of the REIT conversion, and like Q2, these increases to FFO were partially offset by net higher interest expense.

Some additional financial metrics I'd like to bring to your attention include our annualized lease payments at the end of the second quarter are up CAD4.9 million from the end of Q1. Favorable exchange rates accounted for CAD5.6 million of that increase in our annual lease payments, as the euro appreciated 5% when comparing it to March 31, 2013 to June 30, 2013, and the US dollar appreciated 3%. This CAD5.6 million increase was reduced by CAD700,000 as vacancies more than offset the added lease revenue from acquisitions, completed projects and contractual rent adjustments.

The value of our investment property portfolio increased from CAD1.94 billion at the beginning of the year to just over CAD2.1 billion at the end of the second quarter. The three major components of the CAD170 million increase were acquisitions of almost CAD80 million, foreign currency translation of just over CAD60 million as a result of the US dollar appreciating 6% and the euro 4% since the beginning of the year, and fair value gains of approximately CAD30 million.

Our total debt at the end of the quarter was approximately CAD330 million, of which just over 20% is US-dollar denominated. With cash on hand of CAD63 million, that brings our net debt to CAD270 million and gives us a net asset value of CAD1.84 billion, or CAD39.31 per unit.

During the second quarter, we declared CAD24.6 million of distributions to unit holders and CAD49.3 million for the first half of the year. In terms of a payout ratio, on a year-to-date basis, we will have declared distributions representing 71% of our comparable FFO.

In closing, we're very pleased with our performance for the quarter and the year to date on virtually every metric, and I would like to thank our staff for their continued dedication and support to help make it all happen.

And with that, I'll turn it back over to Tom.

Well, thanks, Mike. And with that, we'll open it up, Operator, to questions.

Thank you. (Operator Instructions) One moment, please, for the first question. (Operator Instructions). Mark Rothschild.

In the disclosure you gave for the run rate of rental revenue, what does that assume for the lease expiries in 2013? It sounds like you have some indication already that there will be some of the properties being vacated, so what have you assumed there?

Mark, I'll just break it down. I think we have a fairly clear picture of where a lot of it is headed. We have 5.5 million, roughly, square feet that was coming due in 2013. 2.5 million of that has been renewed now. There's substantial progress further down the road on another 2.3 million square feet, and that leaves about 1 million that would go vacant. These are a couple of properties in Maryland, a couple in Germany and one or two in the United States.

The revenue that comes from those that are being vacated is approximately --

CAD4.1 million, all in.

All in.

And that CAD4.1 million is still in the annual revenue because you don't lose that until the end of the year, correct?

That's right. Mark, it's Mike. When you look at the annualized lease payments, that amount from June 30th -- that number is really sort of looking at what we think it would be as of the June 30th exchange rates based on what we know today and what we've got from notices on those vacancies.

And then, Mark, (inaudible) for trying to just extrapolate a run rate is that we have other properties that had been vacant before that are going to come on-stream in 2014, such as [Green Lane], where we're renovating for Mercedes, and of course the CPI adjustments or the contractual rental increases.

They're not in.

They're not in. So a lot of that, if not substantially all of it, is offset before we then discuss, for example, CAD6 million in new revenue from recent acquisitions, and future acquisitions we hope to make this year. So most of the slippage in renewals and even vacancies pre-releasing is getting offset by CPI, contract and other property (inaudible.)

Okay, that's helpful. And in regards to the tax that you had to pay this quarter, you seemed to say that it's really a one-time thing. Should we expect, though, that if you'd have to repatriate cash again in a year, that there would be -- that this could become something more recurring to a smaller degree, or is this really something we're not likely to ever see again?

Mark, you're not likely to see something of that magnitude again. On an annual basis, from a withholding tax perspective on the cash end, you'll probably see maybe CAD1 million to CAD1.5 million of withholding tax that we would bake into the -- I'll call it to the current tax provision.

And that CAD1.5 million would be, let's say, on top of the CAD1.8 million or so a quarter that you're paying now?

That's not a quarter. That would be --

Okay, the CAD1.5 million is an annual number.

Yes, the CAD1.5 million would be -- CAD1 million to CAD1.5 million would be an annual number, and is probably, to a large extent, baked in the CAD1.8 million.

Okay, good. Your G&A, the number that we saw this quarter -- is this a good run rate that we should expect to see around here going forward?

Mark, it's a bit high. I think it had some nonrecurring in it. We like to think we'll be between CAD5 million and CAD6 million per quarter, sort of in the CAD21 million, CAD22 million annualized and with respect to the 10% target. Of course, I've always said that the best way to do that is to grow revenues without adding new G&A, and based on what we've acquired this year and our rather healthy pipeline, we're certainly headed in the right direction there.

Okay, great. And just, lastly, one more question. It's obviously still a while away, but is there anything at all to disclose as far as the 2017 expiries, just some of your big properties?

No, nothing to disclose in terms of specifics that have occurred there.

Okay, thanks a lot.

(Operator Instructions) Sam Damiani.

Just on the acquisition front, Tom, in the past you've kind of spoken about an annualized piece of CAD250 million at least as a goal. I didn't hear a similar kind of comment this morning. I wonder if you could update us on your thoughts on setting of sort of expectations in that range.

Well, Sam, as I mentioned in my comments, I mentioned that it's a nonconceptual actual pipeline, and the fact of the matter is it is as material as it's ever been. We're involved with some work that has a number of steps that have to be buttoned down. But we've never been more excited about what we're working on. Of course, we have to complete conditional steps, and those are under way.

Yes, in terms of our target, today we feel very confident that the CAD250 million would actually be at the minimum side.

At the minimum size. You've done, I guess, CAD100 million sort of year to date, and you feel that you could do at least that again in the latter half of the year?

Based on the activities happening right now, we're feeling that way, yes.

Okay. And are you seeing any change in the acquisition market in terms of level of activity, perhaps your view on cap rates just given the pull-back in the sector valuations eliminating perhaps some of your competitors from being active today?

What we're observing is more what we're experiencing that was previously kind of talk is now really happening. And that is we truly are an international REIT, and our ability to pursue opportunities in the United States with the team we have in North America, pursue opportunities in countries like Germany and elsewhere is really allowing us to kind of feel right now the differences in different markets.

And more than ever, we're finding a combination of volatility in certain places is opening up opportunities. The strength of our balance sheet is kind of manifesting the true advantage we have without need to raise equity, cash on hand and ability to borrow with the terrific support we have from our banks. We're really seeing that advantageous. It's allowing us to respond quicker, act when others are hesitant, and frankly, right now it's probably been the best window we've experienced.

Not necessarily commenting on cap rates higher or lower in Canada, higher or lower in the United States, just a matter of movement in markets and how we're accessing it and acting on it. And as I say, it's resulted in a pipeline, while conditional, that is indeed material and would exceed anything done thus far this year.

Okay. And then so far, you've basically announced acquisitions sort of once they've closed as opposed to announcing them when they're under contract and whatnot. Can you quantify perhaps the state of any activity on the acquisition front that is under conditional contract or where you've waived conditions pending closing?

Generally speaking, going forward, Granite, as we have in our last two acquisitions -- when a transaction is firm and binding, meaning any conditions of the purchaser, us, or the vendor, our counterparty, are waived, we will announce that. We did that last Tuesday with respect to the Westchester property, a CAD21million acquisition, ten-year sale/leaseback with Fifth & Pacific. All conditions were waived. It was a matter of customary closing conditions. And as it turns out, we expect to close that, candidly, as early as tomorrow. So we announced that last week. We will announce briefly when it closes.

I think that will be our pattern going forward, that we won't wait until closing. We will wait until conditions are waived on all parties' part and firm and binding and announce it. And with that in mind, I don't want to say any more in terms of detail, but when I say material, I do mean significantly more than we've acquired to date.

Okay. All right. And just over to the ALT, does this number that you're disclosing today include also the roll down or perhaps roll up in the rents that you're renewing with Magna this year?

Yes. It will be everything we know to date.

In terms of the renewals, perhaps a down-tick in the --

Yes.

Okay. And what is the quantity of that? I think you were talking maybe a 15% roll down in the leases that you're renewing with Magna this year.

I mean, overall, I think it's between that -- yes, it's around that 15% number. Yes.

Okay, great. Thank you.

(Operator Instructions) Richard Greenberg.

I understand that your priority is growth through acquisition of new properties, but is there a point where your stock has come down enough relative to underlying asset value and is cheap enough on an FFO basis that you would restart the stock buyback program? I mean, how do you look at the returns on a stock buyback versus buying new properties?

It's a fair question, and of course, the whole market has seen decline. We are not at this stage giving consideration to a renewal of the normal course issuer. But really our focus is on growth. We think that the best way to deploy capital is not on a buyback and find ourselves basically caught with no further borrowing power, but rather to acquire opportunistically in these times. We like the fact -- and it's not meant to be to the expense of others, but we know that equity has been and will be harder to come by for a number of others, and we think this is a window of opportunity to buy.

Thus far this year, everything has been north of a 7% cap rate, and that trend has been continuing for us. With leverage, of course, it's putting us into substantial double-digit returns. And we look at it on a long-term basis. We think better to buy, better to build, in certain cases to sell assets. And I can't say where we would say -- let's buy back the stock because the metrics are more favorable from an accretion point of view, but we certainly aren't there right now.

Okay, thanks.

Thank you. Frederic Blondeau.

Just two quick questions here, and sorry if I missed that. It seems like Magna went public announcing a [restructuration] in Europe. I was just wondering how would that affect your operations.

Frederic, in the simplest way to put it, Magna is a tenant of ours in approximately 90 properties. Their businesses in various regions impact new contracts they get when their business is stronger. New contracts come, and probability of retaining them increases. Their growth in different markets doesn't really correlate to impact on our portfolio. We're not building new plants for them, but we are respecting and trying our best everywhere we can to keep them as a tenant and to keep them as a happy tenant.

So quite often, the growth of Magna, be it in China, India, Mexico -- people will say, well, that's great for Granite. And it's great for Magna, and we're happy for Magna, but what matters is where our properties are located, is business going well for Magna, and if it is, it will go well for us.

Okay, but do you plan they could vacate some of your buildings in Europe?

Well, not to any disproportionate level. We've retained them in a significant number of properties this year in Europe already. I'll give you an example of an asset where we would have said a year and a half ago, even a year ago, they wouldn't remain. They just recently signed a five-year extension. So we're not seeing specifically Europe disruption affecting our portfolio in any unusual way. And in fact, a lot of their business in Europe is turning the corner, so we're a little more optimistic about our portfolio.

I might add that the substantial part of our Europe portfolio is in Austria. And sort of the -- anecdotally, the Austrian assets are probably their physically most advanced and attractively located and doing well. So right now Europe isn't a greater fear for us than anywhere else, and we're actually more optimistic than we were a year ago.

Okay, thank you.

And at this time, Mr. Heslip, we have no further questions. I will now turn the call back over to you.

Thank you, and thanks, everybody, for today. Take care.

Thank you. Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines. Have a great day.