Granite Real Estate Investment Trust (GRP.U) 2015 Q4 法說會逐字稿

Welcome to the conference call of Granite REIT. Speaking to you on the call this morning is Mike Forsayeth, Chief Financial Officer and Interim Chief Executive Officer.

Before we start today's call, I would like to remind you that statements and information made in today's discussion may constitute forward-looking statements and forward-looking information and that actual results could differ materially from any conclusion, forecast or projection.

These statements and information 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 Granite's materials filed with the Canadian Securities Administrators and US Securities and Exchange Commission from time to time, including the risk factors section of its Annual Information Form for 2015 filed on March 2, 2016.

Readers are cautioned not to place undue reliance on any of these forward-looking statements and forward-looking information. Granite undertakes no intention or obligation to update or revise any of these forward-looking statements or forward-looking information, 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 standardization meaning under International Financial Reporting Standards. Please refer to the audit combined financial results of the year-end, December 31, 2015 for the Granite Real Estate Investment Trust and Granite REIT Inc. and other materials filed with the Canadian Securities Administrators and US Securities and Exchange Commission from time to time for additional relevant information.

(Operator Instructions)

As a reminder, this conference is being recorded on Thursday, March 3, 2016. I will now like to turn the call over to Mike Forsayeth. Please go ahead.

Thank you, Tara. Before I get into my detailed remarks on the results for the quarter and the year, let me first speak to the conclusion of the strategic review process which was also announced yesterday. As you know, the trustees initiated the strategic review process in June 2015 and Barclays and Brookfield Financial were engaged as financial advisors to assist Granite in the process.

Yesterday, we announced that following the consideration of a full range of available alternatives, the Board of Trustees, supported by the advice of its advisors, determined that pursuing our existing strategic objectives was the best course of action to Granite -- for Granite to follow under circumstances.

The process was extensive and a number of strategic alternatives were carefully considered, including the evaluation of transformational acquisitions, initiating a substantial issuer bid, paying a special distribution, the sale of some or all of Granite's special-purpose assets to one or more potential acquirers, including Magna and of course, maintaining the current strategy.

And up until recently, Granite had been in exclusive negotiations with a private equity fund for the sale of the entire business but the recent disruption in the credit markets adversely impacted the ability to finance the transaction. Granite's strategy has been and will continue to be to build a high-quality, diversified industrial real estate business, patiently grow and diversify its asset base through acquisitions and distribute -- dispositions, optimize the balance sheet leverage and thereby, reducing our exposure to Magna. And we will do this with the same disciplined and opportunistic approach that got us to where we are today.

Also with the strategic review process now completed, the Board will now focus on selecting a permanent Chief Executive Officer. In the meantime, I'll continue in my current role of Chief Financial Officer and interim Chief Executive Officer while supported by the rest of our strong executive team, consisting of John De Aragon, who was recently appointed Chief Operating Officer, Co-Head, Global Real Estate; and Lorne Kumer, who was appointed Executive Vice President, Co-Head, Global Real Estate; Jen Tindale, EVP and General Counsel; and Stephan Wierzbinski, EVP of Europe, all of whom are sitting with me here today.

Now onto the business. Despite the incremental cost associated with the strategic review, we finished the year strongly with some favorable currency winds at our back, but before I get into the numbers, I'll summarize some of the operating highlights for the 2015 year as a whole and including some recent developments.

We executed leases with two high-quality non-Magna tenants for our two completed speculative development properties in the United States. The Shepherdsville, Kentucky property was leased to Game Stop for seven years and was signed at the end of Q4. And the Bethel Township, Pennsylvania property was leased to Samsung for 5.5 years subsequent to the year end in February 2016. These leases represent approximately 82%, or 1.1 million square feet of the total leasable area of those two properties.

The stabilized annual revenue for these two properties is $4.2 million and it will kick in on a staggered basis over -- throughout next year. Including these two -- those two leases, we have entered into new leases, renewals or extensions for 17 properties, representing approximately 3.3 million square feet.

We sold six non-core properties for total gross proceeds of CAD16.3 million, which represented ALT, or annualized lease payments of CAD1.4 million. As a result of the 2015 achievements, we successfully reduced the concentration of ALT from Magna to 79% as at December 31, 2016 and with the Samsung lease in place, our vacancy today is 1.1%.

In addition, we acquired 28 acres of development land in Wroclaw, Poland, involving a three-phase project. Construction on the first phase is nearly complete for a building that is 38% pre-leased.

And despite the slightly higher G&A in what was an unusual year, comparable FFO for the year was CAD3.36 per unit, up almost 3% from 2014, largely as a result of increased rental revenue from Granite's acquisition activities, favorable exchange rates and lower interest costs but together, more than offset the lost revenue and earnings from the disposition of the Mexican portfolio halfway through 2014.

Turning to the financial results of the -- for the fourth quarter; it was another strong quarter. Our FFO was up 9% to CAD0.84 per unit fully diluted and similar to Q3, included a couple of unusual items that on balance, pretty much offset each other.

These unusual items included special committee fees of the Board and advisory costs related to the strategic review process, lower compensation expense due to reduced headcount and a lower unit-based compensation expense and a favorable current tax recoverable -- recovery for certain Canadian legal entities.

Looking at some of the details quarter-over-quarter numbers, revenue for Q4 2015 was CAD54.9 million, up CAD3.9 million compared to last year. The increase was largely due to the incremental revenue related to the acquisition of the Ingram Micro properties at the end of 2014 and favorable US exchange rates as the US dollar appreciated approximately 18% quarter over quarter.

Property and operating costs were in line with our expectations. Our G&A for the quarter was CAD7.6 million, CAD800,000 lower than last year despite the additional special committee fees and advisory costs, which totaled CAD900,000 and relative to last year, we had lower compensation expense due to the reduced headcount, lower unit-based compensation expense, and lower severance costs. Also note there's going to be a few more advisory costs to come in Q1 of 2016.

Interest expense came in, as expected, at our quarterly run rate of CAD4.9 million and also last year, we had significant realized foreign exchange gains of CAD1.2 million that weren't repeated this year. Our current tax provision for the quarter was CAD600,000 while our expected run rate, excluding withholding taxes, has been in the CAD1.1 million to CAD1.4 million range. As I mentioned earlier, the primary difference was a favorable recovery in Canada for certain legal entities.

All of these factors contributed to Granite's Q4 2015 FFO of CAD39.5 million, or CAD0.84 per unit fully diluted. This compares with an FFO for Q4 2014 of CAD36.2 million, or CAD0.77 per unit fully diluted. On an IFRS reported basis, our quarterly net income was CAD45.2 million versus CAD21.5 million for the fourth quarter of 2014, largely due to the after-tax impact of the CAD28.8 million swing in net fair value gains on investment properties.

There are a few additional financial metrics and matters I'd like to bring to your attention and these include: our annualized lease payments at the end of the fourth quarter increased to CAD228.6 million, up from CAD212.5 million at the beginning of the year. The increase is almost entirely driven by foreign exchange, as the US dollar has appreciated 19% and the Euro is up 7% since the beginning of the year.

The value of our investment property portfolio has increased over CAD280 million from just over CAD2.3 billion at the beginning of the year to almost CAD2.6 billion at the end of 2015 and you will see that we have expanded our disclosure in the MD&A with additional detailed information as for the composition of our portfolio and the factors that affected value during the year.

For 2015, the major components of the increase were a net increase in the net foreign currency translation gains of almost CAD200 million; Net fair value gains of approximately CAD73 million, virtually all of which is attributable to our acquired Modern Logistics/Distribution portfolio and the acquisition of development land in Poland; and the CapEx associated with building the first phase of that development as well as the completion of the Berks property.

We declared CAD27 million of distributions to unitholders to the quarter, reflecting a payout ratio of 69% of the quarter's FFO. And we announced a 5.7% increase in our monthly distribution, which, if you think through the math, will result in our unitholders receiving total distributions in FY16 of CAD2.40, up from CAD2.30 in 2015.

Our total debt, including currency swaps, at the end of the quarter was approximately CAD590 million, bringing our leverage to 23%, 18.1% on a net debt basis. This combined with our strong liquidity of cash and available credit lines, totaling approximately CAD350 million, puts Granite's balance sheet in an enviable position and on a solid foundation to successfully achieve our long-term objectives.

Lastly and in closing, I want to thank all of our staff in North America and Europe for their focused efforts and dedication to delivering another solid operating performance in 2015 under unique circumstances. With that, I'll turn it back to the operator to see if anyone has any questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Mike Markidis with Desjardins Capital Markets. Please proceed.

Thank you. Mike, just to start off, it seems, based on your comments, that you guys were in advanced stages with a potential buyer for the assets and -- or for the entire Company. That process obviously fell apart, as you mentioned, due to, it seems, some volatility of the credit markets. Are you able to give us a sense of what range of values were being contemplated prior to the -- by that party -- prior to the process falling apart?

No, sorry.

Okay. Well, then, in terms of evaluating transformative acquisitions, maybe you can just give us a sense of why the decision was made to halt the strategic -- or conclude the strategic review at this point, given that we are seeing some stress in the credit markets. And I'm just wondering if it was considered that perhaps if you waited another couple of months, that might actually give rise to better pricing for assets that might fit your objectives going forward.

I think for us going forward, Mike, we looked at all the alternatives, as sort of outlined. We looked at our -- where we are today, and we came close. We're disappointed certainly, but -- and to your earlier point, the potential gave interesting valuations for us looking ahead.

But on balance, the process now is completed. We're not soliciting any bids, any buyers, and we are moving on and focusing on our Business. We believe that the process confirmed we've got a great Business, and right now we're focused on that and moving forward with it.

Okay. If I remember correctly, the catalyst, or at least part of the reason for the strategic review was that you guys had received at least an expression of interest from a third party about buying some of your larger facilities. Did this process unearth additional demand in that regard or was that sort of a one-off?

No. We had interest on a number of fronts, as I mentioned on the call, to special purpose, including Magna. But that led to actually the opportunity or exploring the opportunity for a sale of the whole, and nothing went any further.

Okay. You guys also mentioned that you went -- it seems like you went down at least the road of approaching Magna, or they approached you, on potentially buying back some assets that they currently occupy. I guess with the conclusion of this process, and not seeing any sales back to Magna, how does that change your view positively or negatively with respect to the potential to renew the upcoming leases at the special-purpose facilities that are on the near-term radar screen, specifically in 2017 and 2018?

No change; Magna continues to invest in those properties. We are optimistic that those will conclude successfully; so, no change from our perspective.

Okay. Have lease discussions on potential extensions gone on in those assets in the last while or has that been off the table?

Right now, those -- they don't come up for another 1.5 years, so we've got -- there is some time on that. We'll be working with Magna over the near term to see if we can facilitate bringing those to a conclusion.

Okay. If I remember correctly, they have the ability to, at their option, to extend? Can you remind us of the terms of their option to extend at those properties?

They're 12 years for the CarMax facilities, and the St. Thomas.

Okay. And there's also two [Cosma] plants in there, I believe? And is that similar?

Yes. The CarMax facility is the Cosma.

CarMax -- okay, but there's four properties in all, excluding the head office, or is it four including the head office?

Excluding head office. There's CarMax -- there is two in Milton, St. Thomas, and the [Preston].

There's -- Mike, it's Lorne. There is three special-purpose properties with 2017 expiries. One is the [Modatek] facility with a January 31 expiry at 2017; and two special-purpose, one in Milton and one in St. Thomas. The Milton is CarMax and the St. Thomas was Format. And then there's another special purpose property, [Press Trend], which is beginning of January of 2018 expiry.

Okay. And Press Trend, that's Brampton as well, is it not?

(multiple speakers) And they are all Cosma.

Okay, and then in terms of timing, do they have to exercise their option within a specific time frame ahead of the expiry, or is it just survive until the actual expiration date?

They need to give us notice 18 months prior.

It is 18 months?

Yes.

Okay. And it's at in-place rent process step; is that correct?

Correct.

It's a CPI with a five-year look-back on the Format and the CarMax space.

Okay. Fair enough. And then just lastly for me before I turn it back, good news there on the lease-up of the two assets in Louisville -- sorry, Shepherdsville and Chase -- or Bethel Township, I should say. Can you just give us a sense of the timing on when that income will actually come on-stream?

The income, from an accounting perspective, will probably come in the second quarter and third quarter of this year.

Okay, that's it for me. Thank you.

(Operator Instructions)

Our next question comes from the line of Pammi Bir with Scotia Capital. Please proceed.

Thanks. Good morning. Can you maybe just -- around the strategic review process, with that private equity group, is there anything to preclude them from coming back at a later date?

No.

And then, with respect to the special-purpose assets, would sales of any of them still be under consideration?

Absolutely.

Is there any discussion going on there?

No.

And then maybe if we think about, in terms of overall non-core asset sales for 2016, what is your sense of what that might look like this year?

We've got 300 contracts currently right now for a total value of CAD25 million, and so that's three of them. We've got a number remaining to go on our books. We've got sort of another 15 to get through over the -- those won't all happen this year, but certainly over the course of the next couple of years -- total CAD65 million in value and about ALP of just under CAD10 million.

CAD10 million on the CAD65 million of assets still -- and what was the ALP on the CAD25 million under contract?

CAD2.9 million.

I'm sorry. Can you repeat that?

CAD2.9 million.

Okay. And then just on the Bethel site with the tenant, I believe that was Samsung -- what is your sense of the, perhaps the additional 250,000 square feet being taken up by them?

They've got to let us know on that in the next month or so -- by the end of March?

Samsung has an option to the end of March for the incremental 250,000 square feet of space, so they will let us know on that then. And then (multiple speakers) --

After that (multiple speakers) --

Is there interest on the balance of it, from other prospects?

We've had a good pipeline on it, but right now we're just focused on the Samsung at the current time.

Okay. And then just on the $4.2 million that you mentioned in terms of annual revenue from those -- from the two leases overall -- I just want to clarify; is that the ALP or is that the gross revenue?

That's the stabilized rent in a full year. So, on an ALP basis -- well, on a revenue basis, we've calculated -- it will start to kick in Q2 and Q3 of this year.

But that is the ALP, correct?

Well, the ALP isn't -- you've got to straightline it from a revenue perspective. So, the ALP does not include the straightlining of the rent, so there was some free rent associated with the -- with both of those in the front end, so they will occupy it earlier on. Although on a -- that's just the nuance associated with that, Pammi (multiple speakers). On an ALP basis, it's about [$1.2 million] or [$1.3 million].

Okay. And then just looking at the 2017 expiries again, can you remind us how much of that CAD50 million in terms of the ALP relates to Magna?

Of the expiries, it is about CAD40 million on the big 2017s; and the [CAD50 million] itself is virtually all Magna.

Okay. And then just looking at some of your -- the rent increases on the contractual rent bumps you did in 2015 versus renewal spreads where you have some leases rolling down, I'm just trying to get a sense overall of how you think 2016 and 2017 -- 2017 might be a bit tougher, just given the Magna space. But what's your sense overall of the 2016 impact on net rents when you combine those two?

I will let Lorne speak to it in a second, but I'll just give a summary comment. We haven't got much coming up in 2016 at all. It's very limited. We've got a couple -- we've just got a couple of leases left to go.

But, Lorne, can you give any other -- ?

Sure. The original 2016 maturities, there were nine leases just under about 1.8 million square feet; ALP of about CAD8.6 million. Seven of those properties have been renewed or extended, and two properties are part of our non-core sales, one of which is under contract. If you pull up the two properties that are for sale, the ALP was slightly up about 2% from the expiry ALP.

Okay. And then just lastly, Mike, your comment on the taxes, the quarterly run rate, I guess, of 1.1% to 1.4%, that excluded the withholding taxes, but if you were to include that -- and I think that one is, again, a little trickier to forecast, but what's your rough sense of what that could look like this year?

If you take that on a quarterly basis, we do dividends out of Europe, and they are lumpy, which is why I exclude it, but that can range from CAD400,000 to CAD600,000. And it's not that it is not accrued. We do accrue it, but it goes into deferred. And then when you pay it, it actually comes out of there and goes into current.

That is the nuance associated with that. But it is probably CAD400,000 to CAD600,000 on an annualized basis when we start to pull dividends out of the European operations.

Okay, and then just lastly for me, when you look at the -- your acquisition views and your comments around that, I sense there's really not much change there, but is there anything -- now that the review process has concluded, is there anything you might be looking at or anything of interest?

We're not right now. As we said, our view hasn't changed. We're not seeing anything in particular from an income-producing property that we're -- that we like right now. Valuations are still high.

That said, we are starting to see a few cracks on the Canadian side. A little early right now, but we would love to do something in Canada; it is our most tax-efficient jurisdiction. So, our eyes are on that.

Also, what you may see is us continuing to piggyback on the success we've had on the development side. We like the jurisdictions. We've got our eyes on Poland and also in the US. We've had good success there, and we will continue to look at that.

Great, okay. Thank you.

Thank you. Our next question comes from the line of Derek Warren with Lincluden. Please proceed.

Hi, there -- it was just a bit more of a question on the growth side. You outlined there with Pammi some of your strategies. I'm just wondering if the same things that collapsed the deal for you guys may be affecting other deals? And would you be open to, in a patient manner, to look at a larger portfolio transaction using your balance sheet?

We'll entertain anything that we think makes sense to us, that meets our objectives, our hurdles, our profile, as it relates to the -- on the acquisition side. So, never say never.

Would your acquisition strategy, if you can just go a little further that, you mentioned that you have a preference to Canada. Can you outline a bit more where you're looking on the development side and where you're seeing opportunities?

I wouldn't say we were focused on Canada; the comment was we are seeing some cracks in Canada. Our focus has been, over the last few years really, in the United States and Europe because our view in Canada was that it was just too expensive.

Our profile continues to be looking in the warehouse logistics part of it. High-quality, new-age buildings in hubs and ports where, overall, you can get a -- you've got great transportation, drivability. If eight hour shifts -- eight hour drive shifts to hit 80 million people. Those are the qualities and the attributes we are looking for.

When you look at your balance sheet over a long period of time, and once you get to where you want to be, what kind of debt would you be looking at? Because you have the opportunity to not take it up to Canadian levels, which arguably are a bit high.

Right now, in the -- the Canadian levels are high. I wouldn't see us, at this point, going above [40%].

Okay. All right, thanks.

Thank you. We do have a follow-up question from the line of Mike Markidis with Desjardins Capital Markets. Please proceed.

Mike, just with the strategic review currently over, I didn't see any mention in the alternatives under review in terms of potential share buyback. Where do you guys stand on that, and would you think you might move to be at least prepared to repurchase some of your shares going forward here?

We did not put in an NCIB, and we do mention that we did look at a substantial issuer bid. So, we looked at that, and, no, we're not looking at that.

Okay. And then can you just expand a little on that comment about seeing some cracks in Canada? I'm just trying to get a sense for everything we've seen here, is that -- there's still tremendous amount of demand, especially for the high income or the very stable component? And maybe you can just give us a sense of what you guys are seeing on that front?

It's just a perspective, given that what we're hearing in the marketplace, and whether it's Alberta -- but it's more that, given the current state of the nation, literally, we think there could be some opportunities for us going forward -- nothing particularly specific, but just in the broad context.

Okay. And would you be open to giving your preference -- not preference, but given your capital allocation to development over the past 1.5 or 2 years, would you guys be open to buying a vacant asset that was built on spec, if that opportunity presented itself?

Sure. Yes.

Okay, that's it for me (multiple speakers).

Depending on what it was, the attributes and everything else, absolutely. And it will -- we believe we can get -- it meets our hurdle rates and economics, sure.

Okay, and then maybe actually just one last one for me then is: How are you guys looking at your hurdle rates on acquisitions just going forward? What is the criteria that you guys look at? Because obviously everything is accretive from a debt perspective, so what are the criteria that you guys use when assessing acquisitions?

Yes, we are looking on the income-producing property side somewhere between 6% and 7%. On the development, 8% and north of 8%. We've been successful on that. Both the Berks and Louisville, we're 8%; and Poland is looking like a 9%, 9%-plus.

Okay. And is this investment in Poland -- do you see that as being a one-off, or how deep are the opportunities for you guys to keep growing in Wroclaw -- I guess I'm saying it improperly -- but in Wroclaw going forward?

Yes, nobody can pronounce it. We think it is a stepping stone to further opportunities in Poland, and we've been working with our development partner there to expand and look at other opportunities.

Okay, that's great. Thank you.

Thank you. The next question comes from the line of Neil Downey with RBC Capital Markets. Please proceed.

The deal that you were going down the road with, with the private equity potential purchaser -- was that contemplated to be a sale of all of the units of the trust, or was it contemplated to be an asset purchase, whereby the trust would effectively redeem its units?

No, it was a sale of the units.

A sale of the units. Okay.

Your Company obviously has very low leverage, let's call it 20% in terms of rounding the numbers. What kind of LTV was contemplated in that transaction, such that the credit markets became problematic?

Their leverage is clearly going to be higher, and for their returns than we would do. But I'm not going to comment on what their loan to value is -- how they were looking to do it.

Okay. Would there have been a certain -- ?

Neil, we'll say, it wasn't crazy leverage, but certainly higher than we do. (multiple speakers)

Sorry, Lorne, I missed that.

A little higher than the typical REIT, but not crazy.

I see. Okay.

Order of magnitude, presumably there would have been some frictional costs associated with the transaction. What might those have been?

They would have there -- I couldn't comment on those either, in terms of what their frictional cost might be.

But I guess they would have been much less than circumstances whereby there would have been an asset purchase? On an asset purchase, would there have been (multiple speakers) -- ?

On an asset purchase, Neil, you would have taxes associated with all the various jurisdictions. In the units, you don't have those -- absolutely.

Right. Okay, that's good. Thank you.

Thank you. The next question comes from the line of Sam Damiani with TD Securities. Please proceed.

Thanks, good morning. I just wanted to get a sense of your -- what you're seeing for debt costs in Europe, with the government bond yields going extremely low in some cases, into negative territory. Are you seeing very, very low debt costs for potential acquisitions and financing of developments?

Yes, I'd say, honestly, I haven't looked at it closely in the last little while, but clearly the Euro rates are more favorable than North American rates, and probably by, I don't know, 100 basis points anyway. I just haven't looked at it that closely, but, no, relatively speaking, more favorable than North America.

Okay, thank you.

Thank you. Mr. Forsayeth, there is no further questions at this time.

Terrific. Thanks, everyone. We will speak to you in May. Thanks again. Bye for now.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.