Granite Real Estate Investment Trust (GRP.U) 2016 Q3 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 this morning are Mike Forsayeth, Chief Executive Officer, and Ilias Konstantopoulos, Chief Financial Officer.

Before we begin 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, and 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 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 2015 filed in 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 standardized meaning under International Financial Reporting Standards. Please refer to the Q3 2016 condensed combined financial results for Granite Real Estate Investment Trust and Granite REIT Incorporated, and other materials filed with the Canadian Securities Administrators and US Securities and Exchange Commission from time to time for additional relevant information.

As a reminder, this call is being recorded Thursday, November 3, 2016.

I would now like to turn the call over to Mike Forsayeth. Please go ahead.

Thank you, [Jose]. Joining me here today is John De Aragon, our Chief Operating Officer, Lorne Kumer, our EVP and Co-Head of Global Real Estate, Jen Tindale, our EVP and General Counsel, and our EVP, Real Estate Europe, Stefan Wierzbinski. I'd also like to welcome Ilias Konstantopoulos, our new Chief Financial Officer, who will be taking you through some of the details of our financial results for the quarter in a couple of moments.

Let me start off by saying we had a very good third quarter, with FFO increasing 6% to CAD0.90 per stapled unit, up from CAD0.85 per stapled unit last year. But, the real accomplishment was the completion of the agreements with Magna announced on October 3, 2016, which dramatically reduced the risks around Magna's lease extensions and provided long-term cash flow clarity.

As a result, the fair value of the properties included in those agreements increased by over CAD160 million from the beginning of the year. Annual rental revenue of over CAD68 million was secured for an extended term, 75% of this amount for 15 years or longer. The minimum contractual revenue associated with the 15 properties increased by over CAD800 million when compared to the remaining minimum contractual rent revenue at the beginning of 2016. And the weighted average lease term for all our properties increased 7.2 years from 4.7 years at the beginning of the year.

With the increased certainty of these long-term cash flows and our confidence in our business prospects, we increased our targeted annual distribution to CAD2.60 per stapled unit, up from the current annualized rate of CAD2.44 and the total distributions of approximately CAD2.40 per stapled unit expected to be paid during 2016.

Following the successful lease transaction with Magna, the logical question is, of course, what's next for Granite. Looking forward, growth remains a key priority for management, and Granite is uniquely positioned as a Canadian REIT. It has a stable, secure, major tenant, Magna, and an international footprint, which gives us access to a unique range of opportunities for new investments across a large number of countries with differing and evolving economic circumstances.

Management is committed to finding investment opportunities that are both FFO and net asset value accretive, but we will also remain disciplined in our approach. Granite will seek to invest in markets that offer the best long-term, risk-adjusted returns with a measured approach, while taking advantage of the wider range and a deeper pool of opportunities that our international footprint provides.

Our strong balance sheet will also allow Granite to capitalize on regional disparities and to take advantage of market disruptions and cyclical downturns, which will inevitably occur in our various markets. We expect to pursue property, portfolio, and Company acquisitions, development opportunities from within Granite's existing portfolio, and from acquired real estate assets in joint ventures and similar arrangements with local operating partners that we think can also enhance our access to investment opportunities and obtain increased local market knowledge and executional advantages.

While Granite remains committed to reducing Magnus concentration over the long-term, given the complexity of the real estate market dynamics, we no longer have a specific target for Magna concentration, and that's with respect to both timing and an absolute percentage. And we remain open to further investments with Magna in support of their growth where the economics make sense, as illustrated in our commitment to acquire the recent building expansions at Bowling Green and Drive.

Management also expects to continue to selectively target the sale of certain non-core properties, primarily Magna tenanted, where it believes it's in the best long-term interests of Granite.

In April, we implemented a normal course issuer bid. Since that time, it's been difficult for us to act, and we have been largely blacked out for various reasons since its implementation. Still, management continues to believe that buying back [stapled] units at appropriate prices is a prudent use of capital. We remain focused on our overhead and cost structure to ensure that Granite's operations are run in a cost-effective and efficient manner while enabling us to achieve our strategic objectives. Granite expects its general administration expenses in 2017 to be lower than both 2015 and 2014 levels as a result of some recent initiatives, including reducing headcount by 15% from 2015 levels, and a reduction in Board expenses. Also, as expected, Magna will be vacating two properties early in the second quarter of 2017, one in Novi, Michigan, and the other in Altbach, Germany. We see these as future opportunities, as management has been reviewing its options with respect to these properties to determine how best to extract value.

Annualized, these revenues these properties contribute, rental revenue of approximately CAD8.6 million. Overall, Granite intends to continue to build a high quality, diversified real estate business by patiently growing and diversifying its asset base. And I emphasize patiently. This is a journey. It's not a race. This strategy relies on a strong balance sheet with comparatively low leverage and available liquidity. This key differentiating advantage provides us with the financial flexibility to pursue attractive growth opportunities across Granite's global footprint at any point in the real estate investment cycle.

And with that, I'll turn it over to Ilias to go over some of the financial highlights for the quarter.

Thank you, Mike. Let me preface by saying that I'm delighted to join Mike and the Granite team. And to those of you on the call who I've not yet met, I look forward to doing so in the near future.

With that, I'll now turn to Granite's financial results for the third quarter, starting with FFO, which in the quarter increased by 6% to CAD42.2 million, or CAD0.90 per unit from the previous quarter a year ago at CAD39.8 million, or CAD0.85 per unit. The increase in FFO was attributable mainly to three reasons, namely the higher rental revenue in tenant recoveries were CAD1.4 million higher, the G&A that Mike referred to for the quarter relative to last year was CAD1.8 million lower, and we also had a reduction in income taxes of CAD0.3 million.

I'll now describe at a more granular level the contributing factors that led to the CAD0.05 increase in our basic FFO for the quarter relative to last year third quarter. So, rental revenue was CAD56.3 million in the quarter, an increase of 1.4%. The 3% increase in rental revenue was due mainly to the following factors - contractual rent adjustments, including CPI-based increases of CAD0.3 million and rent escalations of CAD0.3 million; we had a lease-up of two recently developed properties in Pennsylvania and Kentucky that added CAD1.8 million of revenue and an additional CAD0.3 million in associated rent recoveries. We also had a CAD0.2 million decrease in connection with Canadian lease renewal. These were offset by rental revenue reduction of CAD1.1 million from the sale of income-producing properties and a slightly unfavorable FX of CAD0.1 million.

At the property operating cost level, that remained relatively consistent with only a CAD0.1 million increase from a year ago. G&A expenses, these were CAD6.3 million in Q3 relative to CAD7.1 million in Q3 of 2015. The CAD0.8 million decrease was due primarily to the following - a net expense in Q3 of 2015 related to the prior CEO's departure, which amounted to CAD1.8 million. We have lower professional fees, CAD0.7 million, including CAD0.4 million that were incurred in Q3 of [2015] in connection with last year's strategic review. The cost reductions were largely offset by a CAD2 million increase relating to the valuation of unit-based compensation and the underlying increase in the market price for such units.

Net interest expense for the quarter was CAD4.9 million and was unchanged from a year ago in Q3 2015. The current income tax for FFO purposes decreased by CAD0.3 million as a result of the favorable settlement of an income tax audit. Net income for the quarter was CAD150 million versus CAD47 million for Q3 2015. The primary reason for this increase relates to net fair value gains of investment properties that Mike highlighted. The net fair value gains of our properties was CAD135 million for the third quarter and was largely attributable to the 15 properties for which binding agreements were entered into with Magna as described by Mike at the outset of the call.

I would also highlight that the fair value gains of our investment properties since the beginning of the year is, you'll see in our financials, CAD170 million, with the vast majority of such gain relating to the special purchase properties. The net fair value gain reflects the increase in certainty, visibility, and extended duration of the underlying cash flows of our properties.

Lastly, I'd like to highlight a few additional financial metrics that we, and suspect you, focus on. Our annualized lease payments, ALP, at the end of the quarter were CAD221 million, roughly, down about CAD7.9 million relative to the beginning of the year. The components that contributed to the decrease were as follows - we sold properties which reduced ALP by about CAD4 million. We expect some vacancies in Novi, Michigan and Altbach, Germany to the tune of CAD4.1 million. Unfavorable FX caused a further decline of CAD5.4 million. Lease extensions and renewals contributed to a CAD0.8 million decline, offset by a CAD3.9 million increase from the net impact of leasing activities, including the lease-up of the development properties in the US and Poland, and, lastly, a CAD2.4 million increase in contractual rent adjustments.

The IFRS value of our investment property portfolio now stands at CAD2.675 billion as at September 30th. We made no purchases [under our] (inaudible) during the quarter. Our total debt at the end of the quarter was approximately CAD572 million, with corresponding leverage of 21%. On a net of cash basis, with CAD175 million of cash, our leverage would be approximately 15%. Our unitholders equity was CAD2 billion at September 30, and our distributions declared during the quarter were CAD28.7 million, reflecting a payout ratio of 68% of our FFO.

At this point, I'd like to turn the call back to Mike.

Great. Thank you, Ilias. In closing, I'd just like to thank all of our staff in North America and Europe for their continued dedication, support, and contributions towards Granite's success. And with that, I'll turn it back to the operator and see if anyone has any questions on the quarter.

(Operator instructions.) Mark Rothschild, Canaccord.

When you look at financing your growth from here, do you view the unsecured markets as a key area of growth? And I guess the second part of the question is, now that you've accomplished this leasing with Magna, would this allow you to maybe utilize more leverage in the unsecured market, or finance those assets with the secured offering? And also, would this -- as the credit rating agencies commented as far as would this help your ratings, the new leasing?

Thanks, Mark. The unsecured market remains our primary market for financing, absolutely, and certainly the deal with the October 3 announcement certainly enhances, we believe those opportunities.

As it relates to our credit ratings, certainly don't see any movement on that because, really, a key determinant of any improvement in our ratings, going forward, is likely going to be our size, not necessarily anything else. But certainly, it was well received by the credit rating agencies, and certainly our current bondholders. But we do see opportunities on the unsecured, going forward, to certainly support our growth. We will likely continue to be largely an unencumbered asset borrower as opposed to a secured borrower.

My only other question, and I feel bad asking about future lease expiries when you've done all this, but in 2018 there is a sizable amount of lease expiries. Are there any notable properties in there that you can point to that we should just be aware of as far as what's coming up in that time? And just confirm for me, I don't think there are any special purpose properties in that group.

No, you're correct, Mark. There are no special purpose properties in the group. The next special purpose property that comes up for renewal is Lannach in 2022, and for 2018 there really aren't any leases of any significance that we're concerned about at this time as it relates to rolling off or becoming vacant.

Sam Damiani, TD Securities.

Mike, your comment on Magna concentration and the lack of target in terms of concentration levels, going forward, and timing of that, is there at least a goal in terms of the direction of that concentration to bring it down, over time?

There is, Sam. As I say, we want to bring the concentration down. And as I mentioned, just the real estate market dynamics in terms of the plus and minuses in terms of getting there at a particular point in time is difficult to predict. We will exit properties through our disposal of non-core, and we're also looking in certain instances, as we did with Drive in Bowling Green, to points in time, if the economics work, actually increase our concentration. But also, it's also driven certainly by our special purpose properties in that sense. But, yes, over the long-term, the objective is to bring it down, but we just don't want to set a specific target at this point.

And just looking at the ALP, in the MD&A you describe a couple of properties, Novi and Altbach, where you expect Magna will vacate. Just trying to understand the roll-forward of the ALP. It looks like one of those two properties is reflected in the Q3 ALP, but maybe not the other, because the total impact was CAD8.6 million.

Yes. And the CAD8.6 million is an annualized revenue. The ALP, if you remember, goes end of September to end of September. So, with those two properties coming off early in the second quarter, you've got a little bit of a mismatch there that you just have to sort of back into.

Sorry, they come off early Q2 [2017]?

Yes, so I think one is March, and the other one's April.

So, in other words, the ALP that you've got for Q3 has a full revenue of those in it?

No, it has probably six months of it.

Six months, okay. And just for the IFRS increase there, I wonder if you could walk through a little more granularity how you did the math to increase those valuations in terms of any change in terminal cap rate. Obviously there was a reduction in I guess leasing CapEx expected, and the increase of probability of renewal, because they did renew. But, I wonder if you'll just walk through the key contributors and to quantify each part of that to some degree.

I'm not sure I'm going to be able to quantify each part of it, but in terms of the key contributors, we use, like most, our ARGUS runs, discounted cash flows on a 10-year discounted cash flow. But, the certainty associated with these revenues and a term added on impacted what we'll say is the discount rate and the terminal cap rate. And as well, given that the term on a lot of these goes beyond what you would ordinarily see in the 10-year cash flow, that will also influence the value.

Just curious, the reversionary NOI in year 10, is it actually higher now than you were previously modeling?

No, it wasn't higher.

(Operator instructions.) And there are no questions at this time.

Terrific. Well, thank you, everyone, for taking the time to hear our call today, and we look forward to talking to you in March. Thanks very much. Bye for now.

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation, and ask that you please disconnect your line.