Granite Real Estate Investment Trust (GRP.U) 2016 Q4 法說會逐字稿

Welcome to the conference call for Granite REIT. Speaking to you on the call this morning is: 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 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 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 2016 filed on March 1, 2017.

[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 and 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 audited combined financial results and management's discussion and analysis for the year-end December 31, 2016 for 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.

As a reminder, this call is being recorded today. I will now turn the call over to Mike Forsayeth. Please go ahead, sir.

Great. Thanks very much. Welcome, everyone. Joining me here today is: John De Aragon, our Chief Operating Officer; Lorne Kumer, our EVP and co-Head of Global Real Estate; our EVP Real Estate Europe, Stefan Wierzbinski; and of course, Ilias Konstantopoulos, our Chief Financial Officer, who will be taking you through some of the details of our financial results in a couple of moments. You'll note the absence of Jen Tindale, who was our General Counsel. Jen has accepted another position for personal reasons, mainly a job that was 20 minutes from her home instead of nearly two hours and we wish her all the best. Our search for a new General Counsel is well underway.

Operationally, our fourth quarter came in line with our expectations, although you'll note that the reported results reflect the impact of the costs associated with the debenture redemption in December 2016, a higher stock-based compensation due to our appreciating unit price, and an additional accounting straight-line adjustment resulting from certain leases included in the Magna lease deal announced in October. The underlying cash flow generated from our real estate operations was well on track and there were no surprises.

Our fourth quarter closed out a very good year for Granite. With the achievement of Granite's 2016 strategic priorities, we entered 2017 with: long-term stability and enhanced visibility of our revenue streams; an overall portfolio weighted average lease term of seven years, 10.7 for the special purpose properties; a favorable debt maturity schedule with a weighted average interest rate of 2.53%; a fifth consecutive annual increase in our distribution; a balance sheet unencumbered by secured debt; a lower cost of capital; and borrowing capacity in excess of CAD1 billion using our targeted leverage ratio in the 40% range.

Looking forward, we see value creation opportunities as we build on our solid foundation by not only investing in our asset base by leveraging our balance sheet but also by actively managing our existing real estate portfolio. As I said before in 2017 and beyond, we will pursue property and portfolio and potentially Company acquisitions with a focus on capitalizing on any regional disparities and market disruptions across our international footprint.

We will pursue development opportunities from within Granite's existing portfolio and from acquired real estate assets. We'll look at joint ventures and similar arrangements with our local operating partners. We'll continue the targeted sale of certain non-core properties, primarily tenanted by Magna. We'll look to doing further investments with our tenants including Magna in support of their growth.

With that framework as a backdrop, I'll outline some of our key priorities for 2017 and give you some color on the market and how that's influencing where we have been and where we will be spending our time. The two immediate priorities within our existing portfolio are, one, address the three known vacancies in 2017: a 307,000 square foot facility in Novi, Michigan; a 300,000 square foot facility in Altbach, Germany, both of these expire after Q1; and nine acres of land in the GTA that is currently under option to Magna.

Annually, together these have contributed about CAD9 million of revenue. With respect to Novi, we've engaged a local partner and we're seeing some good interest in the site in the form of RFP's that we have responded to as we look to reposition the building. In Altbach, Germany we're working through the close-out process with Magna and evaluating a number of future use options. For the nine acres in the GTA, we are in the process of preparing to market the site for lease, perhaps a build-to-suit or for sale.

Our second priority with respect to our existing portfolio is lease expiries, with only two leases remaining to be renewed for 2017, representing only 123,000 square feet. We have 29 leases coming up for renewal in 2018. These represent approximately 4.2 million square feet and almost CAD25 million in revenue. Most of these relate to the previous 2013 expiries that were renewed for five years and we're expecting a strong retention rate again this time around.

From an acquisition perspective, we've been actively looking and have reviewed over CAD2 billion of potential opportunities, the vast majority of which has come out of Europe and where we are starting to see more portfolios for sale, particularly in Central Europe where a number of funds are starting to monetize their investments. We see this as a positive development for Granite. In Canada, pricing remains too frothy for us and we're finding that the underlying value of our lands, primarily in the GTA, are pushing us towards looking at redevelopment and repositioning certain of our properties towards an alternative highest and best use. While in the US, we're seeing some value-add opportunities through our local partners that could be attractive to us.

We still like development. On that front, in addition to the repositioning examples I already mentioned, we are exploring the development opportunities pertaining to our 30 acres in Indianapolis, Poland is continuing through its lease-up process and we are also continuing to evaluate the development options related to the 20 acres of land adjacent to our Milton properties. Lastly, Magna Granite continued to discuss further investment opportunities within our portfolio to accommodate Magna's own growth.

Overall, with how Granite is positioned, certainly my enthusiasm for Granite's prospects in growth and value creation have never been stronger. Execution continues to be the key to unlock value, but so is patience. Investing in real estate is a long-term proposition and best suited for those investors with a similar long-term horizon. As a management team, we're focused on just that, long-term value creation. With that, I will turn it over to Ilias to go over some of the financial highlights of the quarter.

Thank you, Mike. Good morning to all. I will briefly walk you through the financial highlights for the fourth quarter and year ended 2016. Granite generated FFO during the quarter of CAD26.2 million or CAD0.56 per unit versus CAD39.5 million or CAD0.84 per unit in the prior-year period. The decrease in FFO was attributable mainly to CAD11.9 million or about CAD0.25 per unit in redemption costs incurred in connection with the issuance of CAD400 million of debentures in December, as well as a slight decrease in rental revenue of about CAD6 million and an increase in current taxes of CAD0.7 million.

The CAD400 million worth of debentures have a tenure of seven years and mature in November of 2023. They were swapped into [Europay] interest at a rate of 2.43% to hedge in part our euro denominated cash flows from our European properties. The proceeds from the debentures, together with available cash, were used to: one, redeem early all of our CAD200 million worth of 2018 debentures; two, purchase the minority interest in five properties for a total consideration of CAD21 million, including a contingent consideration component and refinance CAD105 million of related secured debt; and three, to fund CAD72 million in building expansions that we acquired from Magna in January of 2017.

As a result of the debenture refinancing, Granite expects to realize annual interest savings, as Mike mentioned, of about CAD2.8 million or approximately CAD0.06 per unit going forward. Our weighted average cost of debt is 2.53%. Our total leverage stands at 25% and our liquidity in the form of cash and cash equivalents as well as an available unsecured credit facility is available and was extended by one year and matures in February of 2019.

Additional highlights for the year ended 2016 include: FFO of CAD149.7 million or CAD3.18 per unit versus CAD3.36 a unit in 2015. The year-over-year decrease in FFO is attributable primarily to the CAD11.9 million in redemption costs previously discussed. The other key components impacting the FFO change include the following.

The year-over-year rental revenue increased CAD7.1 million or CAD0.15 per unit and was comprised of the following three components: favorable FX rate movements of CAD5.2 million as a result of the Canadian dollar depreciating relative to both the euro and the US dollar on average during the year; number two, contractual rent adjustments, completed projects coming on stream, leasing renewals and certain other smaller items contributed in aggregate CAD5.2 million; and third and lastly, offset by property disposals that reduced revenue by about CAD3.2 million.

On the expense side, property operating costs increased by CAD0.5 million. G&A decreased slightly by CAD0.3 million. Interest costs were about CAD0.9 million higher. Lastly, current taxes increased by CAD3 million primarily due to our foreign jurisdictions and more specifically, Austria. Taken together, the net increase in the forgoing expenses was CAD4.1 million or about CAD0.09 per unit. On the balance sheet side, the IFRS value of our investment property portfolio stood at CAD2.65 billion as of December 31, 2016, implying an overall capitalization rate of 8%. You will note this additional disclosure on page 12 of our MD&A.

During the year, Granite recorded total fair value gains for the investment properties of about CAD176 million, primarily attributable to the positive changes related to the renewals and extensions associated with the 15 Magna properties as previously announced on October 3, 2016. We paid maintenance or sustaining capital expenditures of CAD2.1 million and spent CAD17.2 million in developmental or expansion CapEx. Lastly, we sold seven non-core properties for gross proceeds of CAD42 million in the year.

At year-end, the carrying value of our total debt was approximately CAD657 million, which corresponds to a total leverage of 25%. Our unitholder's equity was CAD1.95 billion, which is after deducting CAD232 million in net deferred taxes. Cash flow from operating activities for the year were CAD160 million and were largely unchanged year-over-year. You will note in our statement of cash flows that we provided additional disclosure to highlight leasing commissions that were paid in the order of CAD2.5 million and tenant allowances that were paid in the order of CAD1.2 million in 2016, which compare to CAD1.6 million and CAD0.6 million, respectively, in 2015.

Lastly, distributions paid were CAD2.40 per unit and CAD2.30 per unit in 2016 and 2015, respectively, with corresponding pay-out ratios to comparable FFO of 71% and 68%, respectively. Annual distributions for 2017 are CAD2.60 per unit based on the current monthly distribution amount of CAD0.217 per unit. Lastly, we made no purchases under our normal course issuer bid during the year since it was first implemented in April of 2016. At this point, I will turn the call back to Mike.

Thanks, Ilias. Granite's success in 2016 was driven by its people, a strong management team, a supportive Board, and excellent staff. In closing, I would like to thank all of them for their continued dedication to Granite. With that, I will turn it back to the operator to see if anyone has any questions.

(Operator Instructions)

Sam Damiani, TD Securities.

Just on your comments on the acquisition front, Mike, you talked about opportunities in Central Europe, could you just give us a sense as to what sort of properties are available and what sort of markets and what the cap rates are like in the marketplace there?

What we're seeing, it's -- when I say Central Europe, Poland is a strong theme when we're talking about that and also Germany, a little bit in the Netherlands. And what we are seeing is Poland, there's a lot on the market, some of the hedge funds are looking to monetize their investments. It's just an observation at this time. Cap rates right now are -- right now the expectations are a little high from where we would like, but we will see how that develops.

Mike, what is the difference in the cap rates in that market relative to, let's say, Western Europe or Canada?

I would say 7%, 7.5% in that market -- in that Polish market and certainly in Canada, you know it's sub 5% (laughter).

What about in Alberta? Are you looking -- is there any desire on your part to get involved in that market potentially as that market recovers overall?

We will see how the pricing -- the industrial side has held up reasonably well in Alberta, at this stage, but we will see how that develops. Canada is our home market, we would love to invest here. We're just going to wait it out a little longer.

Okay. Maybe just to finish up and then I'll turn it back, is just on the straight-line rent in Q4, if you could give a flavor as to what that's going to look like in Q1? What specifically sort of drove that relatively large number in Q4?

Yes, the large number in the fourth quarter, largely, as I mentioned in my opening remarks, was as we did the transaction with Magna in October 3, really primarily, a chunk of that related to the head office. So the releasing of that and the extension of that, as we said earlier, that rent was virtually cut in half overall. Then, that just actually in the accounting world, you start that over from the day you actually do -- you sign the renewal.

So that is what really drove it, as well as a couple of other small ones. So, you will see that sort of go through, overall, through that renewal. So, Q1, I suspect will be similar to Q4 as it relates to that straight-line adjustment going forward.

Then so just remind me, the Magna head office on cash rent basis -- that rent was to continue through, I think, was it the end of 2017?

That's correct. Yes, cash basis, you're bang on, Sam. The cash will continue through -- no sorry, the cash will change January 1 of 2017.

Okay, so that should drive a much different straight-line rent number in Q1 then? No?

No, it starts -- you do it right from October -- actually, we had to do it from October 1 and say, here's the cash coming in for the next 6 years, 6.25 years and divide that by 6.25 years.

Right, but if the cash rent is dropping from Q4 to Q1, and I'm going to assuming it's dropping.

No, the straight-line won't drop, the cash will drop.

Exactly. Sorry, but the adjustment will narrow because the Delta is going to be much different.

Yes. Fair point, yes.

Okay, thank you.

(Operator Instructions)

Pammi Bir, Scotia Capital.

Mike, just going back to the comments around the European acquisition environment, can you comment on the quality of the assets that you're seeing? Then secondly, are you feeling more confident today than, say, a few months ago on being able to transact?

On your first point, I would say mix quality on the asset side. We're seeing some of the portfolios, we're seeing some good stuff in it with some not so good stuff in it. But we are seeing some decent quality in the portfolios, but some of it's got some hair attached to it, not anything necessarily one couldn't deal with but it's all about price. And in terms of your second question, yes, with more volume and more activity, yes, I feel better about the ability to transact then we probably were 6 months ago, yes.

And just on that, do you have any expectations of how much of the cash that you are sitting on could be deployed over the course of the year?

It's really hard to say, Pammi. We looked at one that was significant and could take up a lot of cash and take up a lot of capacity, so it is going to be situational, but we're seeing some portfolios of size.

Okay.

Sorry, I can't comment on terms saying exactly when.

Okay, maybe just switching gears. Just going back to your comments around the Indiana asset or the development opportunity there, is that site currently being marketed? Have tenants expressed any possible interest?

It is in the planning stage right now. So, nothing -- I'd just say, we're just working on the planning stage, we have no tenants that have been identified or anything else, but it's in a very good market and a good park.

Okay, so it sounds like it is still fairly early on that?

It is early on, yes.

Right. Okay, then maybe just lastly, just wanted to clarify, but with respect to the Magna vacancies -- or the upcoming vacancies in Q2 for the German and the US, those two properties, and then you combined that with, I believe, roughly CAD6 million of rent reductions that were negotiated, part of the lease extensions, is all of that fully -- are those full annual amounts reflected in your annualized lease payments?

Yes, the ALP -- go ahead, Ilias.

I'm sorry, I was going to say Pammi, that in the ALP there are the 3 months that are actually going to be received in FY17. The annual run rate of those particular properties that Mike referred to was CAD9 million, of which some is in the ALP, because we do take in ALP the months that we will receive rent. But for purposes of annual run rate, the aggregate of the vacancies would be CAD9 million.

Got it. Then maybe just lastly, just given all the discussion around US trade policies and possible implications there, can you just comment on any implication you see with respect or possible implications, I guess, with respect to your portfolio? Are there any areas of concern with respect to any of the US assets or even the Canadian asset just given the Magna exposure?

Hang on to that thought, Ilias had a follow-on comment on your -- on the revenue side.

Yes, I was only going to add a little bit more context around those vacancies. The offset of course, Pammi, to state what was previously stated, is the expansion that we bought, would also contribute and of course, those would contribute about $4.4 million or roughly CAD5.9 million a year.

Got it.

That whole transaction overall, cash-wise was pretty much neutral on an ongoing basis, Pammi.

Right.

So I just wanted to make that point. Your question as it relates to -- I think you're referring to NAFTA and the potential renegotiation of that?

Right.

Yes. From our perspective, a few things, one, thinking of our largest tenant in Magna -- you've heard Magna, they released their results, they've spoken to the fact that, yes, there could be potential negative implications to them in the global OEM world. But the key point also is, it's really early, nobody really knows at this stage.

As you think of us in particular, we're not -- we're out of Mexico. In the Canadian side, we have renegotiated our three largest properties there through 2032. Also, we are actually seeing expansions and investment in our Canadian properties from the perspective of Magna. The last point, on the US side, to the extent that there is more US emphasis, that actually positions our US properties pretty well.

Got it. Thank you.

Sam Damiani, TD Securities.

Just on the 2018 expiries, can you give us some color in terms of the number of properties, some of the largest properties in that group of assets?

Some of the largest ones, maybe I will just have (inaudible) --

The type's too small here that I can read, Sam. (laughter) I'll -- why don't I come back to you. I'll come back to after on that.

There's a mixed bag, there's 29 leases across that group. There's some coming out of our -- in Europe, the Netherlands and in Germany that are coming through, but the bulk of it really related to a lot of smaller properties from in the Magna portfolio that we had in 2013 that got turned over and released for 5 [years] as I mentioned in my opening remarks. There's nothing really of huge size in those 2018's that would tip it one way or the other, overall.

It's probably too early to talk about what the rent is going to be on the renewal. But as I think back to 2013, there was a bit of a reset lower, I'm going to throw a number out, of the order of 10% to 15% on the rent. That probably isn't accurate.

But would you say that the market rents for these building have been stable? Have increased or decreased? You don't want to tip your hand here obviously too, but is there any color you could provide in terms of guidance (multiple speakers)?

I think on the -- your observation is right and that was on the Magna properties, in terms of there were reductions. We are not expecting to see that again this time around, by any stretch. So we've got -- there's about 14 in there of the -- that represent about CAD7.5 million of ALP in those 2018's. We're not expecting to see any reductions there, potentially some uptick but certainly not looking at any reductions.

On the other side, as it relates to the rest of the portfolio, there may be some opportunities on the renewal side in the rest of it.

Is there any inducement being talked about with Magna to affect these?

No.

No? Not like there was in [grats]?

No, no. We're not going there again.

Okay. So if you were to make an acquisition in the sort of 7% to 7.5% cap rate range in Poland, what is the financing environment in that market like to put 5-year to 10-year debt on those properties? Or would you look at doing a Canadian swap deal again?

We'd look to continue with our existing finance philosophy, that is go unsecured and swap to euros.

Okay. Just quickly, the rationale for the unsecured as opposed to doing some secured locally? What is the rationale there?

I think it's -- for us it is a bit of ease of administration. There's not a big spread from our end in terms of going specific property by property. It gives us a little more flexibility overall in terms of, I'll call it, pushing the money around from a corporate cash flow perspective.

Just as a practical matter, I think we'd resort to our cash given the magnitude of investment we would contemplate making in Poland, so there is ample liquidity.

Okay. That is helpful. Okay, that's great, I will turn it back. Thank you.

Alex Avery, CIBC.

Mike, you talked about the acquisition or I guess the market for acquisitions in Poland and that you are optimistic that you will see more properties come to market. Can you provide some goalposts in terms of where your expectation is that you would like to see Granite's leverage over time, contingent on finding the right real estate and being able to acquire it?

What that equates to in terms of dollar value? What kind of, I guess, some goalposts on time horizon? Is this a longer-term target of reaching a certain leverage level or a certain dollar value of acquisitions?

We've been pretty -- in the past, our target leverage ratio overall is in the 40% range. That equates to roughly over about CAD1 billion of debt capacity, without issuing any equity.

In terms of the deployment of that, we would love to deploy that as quickly as we can. That said, we're going to be -- as we've consistently said, we're going to be patient about it. But that is the total dollar value that we are looking at and if things go well, we could deploy a large portion of that at any point in time.

It's really difficult to say, Alex, in terms of when that actually is going to occur, but the bottom line is we want it to occur. We want it -- to use it and extract the value out of the balance sheet, but it is difficult to put a time horizon on it.

Okay, I guess you noted the opportunity in Poland in the event that you had the opportunity in 2017 to put CAD1 billion to work in Poland, is that something that Granite would be comfortable with in terms of increasing your geographic exposure to that market?

I wouldn't go all in Poland. I wouldn't put CAD1 billion in Poland. If you'd look at in the context of the CAD1 billion, we would like -- certainly, our key markets in Europe would be, Germany, the Netherlands, the UK, Poland is interesting but I'm not going to look to put CAD1 billion in it.

Equally, we want to save a little room for perhaps in the US, where we see some -- we're seeing some opportunities there as I mentioned on the value added side. So when we talk about the CAD1 billion, it's not to put it all in one spot, it's to, I'll call it, sprinkle it around in some of the -- in where -- in our core markets.

Do you think it would be reasonable to expect that you would be able to complete CAD1 billion of acquisitions 5 years from now?

I would like to say 5 years from now, that we should be able to crack that, yes.

Okay, that's great. Thank you.

There are no further questions. We have no other questions at this time, sir.

Okay, I just want to -- we've heard the word Poland a lot (laughter) and I just want to qualify just to say that Poland is where we're seeing a lot of volume come in, it doesn't necessarily mean we are jumping in both feet into Poland. So, I just want to make that qualifier. That is where we're seeing the trend, as I mentioned, just in my last comments with Alex, is our core markets have been Germany, the Netherlands or looking at the UK, the US and would still love to do something in Canada. But I just want to make sure that nobody thinks we are jumping into Poland with CAD1 billion to spend.

With that, if there's no further questions, I will close it off. Thanks everyone very much. Bye for now.

Ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation. Everyone, have a good rest of the day. You may disconnect your line.