Granite Real Estate Investment Trust (GRP.U) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the conference call of Granite REIT. Speaking to you on the 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 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 U.S. Securities and Exchange Commission from time-to-time, including the Risk Factors section of its annual information from 2016 dated 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 or forward-looking information whether as a result of new information, future events or otherwise, except as required by law.

In addition, these 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 2017 condensed combined financial results and management's discussion and analysis of Granite Real Estate Investment Trust and Granite REIT, Inc. and other materials filed with the Canadian Securities Administrators and U.S. Securities and Exchange Commission for additional relevant information. Please note this call is being recorded Wednesday, November, 8, 2017. I would now like to turn the call over to Mike Forsayeth.

Thank you, operator. Joining me here today is John De Aragon, our Chief Operating Officer; Lorne Kumer, our EVP and our head of Global Real Estate and Ilias Konstantopoulos, our CFO, will be taking you through some of the details of our financial results in a couple of moments. Our results were a little noisy again in this quarter, but on the positive end this time. And from an operating perspective, our results continue to be in line with our expectations. We also announced our sixth consecutive annual distribution increase. This year, we're increasing it 4.6% to an annualized target distribution of $2.72 starting with the distribution payment expected to be made in January.

As I mentioned, there are couple of items that favorably impacted this quarter's results. First, a $1.2 million lease termination penalty associated with Siemens, exercising their early termination option at our 250,000 square foot building in Tilsonburg, Ontario. I mentioned this in my remarks last quarter. We're also negotiating with the tenant their close-out and restoration obligations under the lease, which are not insignificant. This is not a core property for Granite, and we are considering all of our options and -- including the likely sale. And we reported over $400,000 of close-out revenue at our Altbach property in Germany that was vacated by Magna in July. Given the strong real estate fundamentals of this property's location in the Stuttgart region, we see an excellent opportunity to reposition this asset. As mentioned in previous calls, we are working with the municipal authorities to rezone this property for the possible redevelopment and to repurpose it for a broad range of industrial uses. Together, these 2 items favorably impacted our FFO and AFFO by a little over $0.03 per unit. Also, of note, we've made some purchases under our automatic NCIB in excess of $10 million as we nibble around the edges as I've often characterized it. Ilias will provide you with additional details on the financial results of the quarter shortly.

Operationally, there's been a lot going on. As I said, following the Q2 proxy events, it's back to business. Here are some operating highlights of the quarter, some of which have been previously announced. On October 6, we closed the IDI acquisition of 3 investment properties in the U.S. for USD 122.8 million. That, with an ingoing yield of 6.1, is expected to generate a stabilized annual revenue of USD 7.9 million or NOI of $7.5 million.

This opportunity had been in the works for some time and we believe it's a great transaction for Granite consistent with what we've done in the past. It ticks all of our boxes from an investment criteria perspective and is representative of the kind of deals we look for and we like to do. The acquisition was funded with cash and utilizing a portion of our credit facility. Given the bulk of our cash resides in Europe, we will be incurring some incremental interest expense on our line until that cash is brought home, which we expect to be closer to the year-end.

Repatriating that cash we'll also have some incremental withholding tax expense of approximately $1 million. As a result of the incremental interest expense in Q4 and the withholding tax payment, this acquisition will not have a significant impact on our Q4 results, but certainly will beginning January 2018. Following the acquisition of the IDI properties, we continue to be actively looking for more acquisitions in our core markets in North America and Western Europe.

On the last call, I said we had a few irons in the fire, of those irons we landed the IDI deal. We're working to increase the deal flow and surface a more viable product as we remain committed to accelerate the deployment of the balance sheet and achieve our growth and diversification objectives. With respect to potential asset sales, we've listed 8 properties for sale in the GTA comprising one almost 9-acre land parcel that is leased to Magna until December of this year and 7 contiguous properties in new market, all with coterminous lease expiries that we see as a residential play for a potential developer. These 8 properties together generate about $3.1 million of revenue.

On the leasing front, we've made strong progress in reducing what little vacancy we have. We signed a 20-year lease with Hanon Systems for 71% of our building in Novi, Michigan, that would have Granite invest approximately $17 million, comprising $13 million in TIs and $14 million in landlord's work and leasing commissions. This will generate annual revenue of approximately USD 3.4 million, NOI $3.2 million beginning in January 2018. This property was vacated by Magna at the end of March 2017. The first phase of our development in property in Poland is now fully leased. And we're looking to pre-lease before we fill the remaining 2 phases in this project. We've had some expressions of interest, but nothing solid to report just yet. We signed a ten-year early lease renewal with a 7-year break option with Meyer & Meyer at our 303,000 square foot facility in Peine, Germany. The previous lease expiry was October 2019, it's now December 2026, given the break option. We have 29 leases expiring in 2018, representing 4.1 million square feet of space. It remains early days but to date 7 leases totaling over 1.1 million square feet have been renewed. There have been 5 leases representing approximately 826 square feet where the tenants have decided not to renew. And of those 5, one of them is a new park property that has been for sale.

So to summarize, operationally, it was a solid quarter with strong progress made on our key strategic priorities of growth and diversification. Our cash flow continues to be steady, strong and growing. We remain focused on our G&A and it continues to decline. With the significant and FFO accretive IDI acquisition, the lease at Novi and Poland, we estimate that beginning in 2018, we'll have effectively reduced our Magna concentration from a revenue perspective down to approximately 70%, down from 76% at the beginning of 2017.

Looking forward, we see the potential for continuing improvement in these metrics supported by the borrowing capacity available from our strong balance sheet. Lastly, as it relates to Granite finding a new CEO, the board is actively engaged with an executive search firm. That's about all I can tell you about that, as I'm not in a position to comment as to when it might be concluded. And With that, I'll turn it over to Ilias to go over the financial highlights of the quarter.

Thank you, Mike, and good morning. Generally, results for the quarter and for the 9 months year-to-date are in line with our expectations from an operating perspective. Revenue for the third quarter decreased $1 million to $55.3 million from $56.3 million in the prior period. Revenue for the 9 months year-to-date decreased $3.6 million to $165.5 million from $169.1 million in the prior year period. The main contributing factors to the net decrease in revenue for the quarter and for the 9 months year-to-date were as follows: the vacancy at our Novi, Michigan property on March 31, 2017, a lease expiry in the third quarter for the Altbach property that Mike mentioned as well as the disposable of income producing properties in the prior period as well a reduction in rents for certain properties in Canada and the U.S. that were previously renewed or extended, partially offset by the lease of development properties in Poland and in the U.S., FX, which had a net unfavorable impact for both the third quarter and the 9 months year-to-date period as a result of the strengthening of the Canadian dollar, particularly against the U.S. dollar.

These factors that I just mentioned were partially offset by the contractual rent increases from our base portfolio that comprised both CPI-based and fixed contract increases. As well, incremental rent from the building expansions you recall in Bowling Green, Kentucky, and Piedmont, South Carolina, that we acquired earlier in the year. As well, the lease termination fees and closeout costs earned in the third quarter that might also reference at our Tilsonburg, Ontario, facility and Altbach, Germany properties also had an offsetting impact.

Each of these previously noted factors is described in further detail and quantified on pages 6 and 7 of the MD&A in our Q3 report. For the third quarter, our reported FFO was $40.5 million or $0.86 per unit versus $42.2 million or $0.90 per unit in the prior year period. The favorable impact of the lease termination fees and closing costs earned in the quarter amount to about $0.03 per unit.

For the 9 months year-to-date, our reported FFO was $111.6 million or $2.37 per unit compared to $123.5 million or $2.62 per unit in the prior year period, representing a decline of $0.25 per unit. The impacts of the termination fee and closeout cost of $1.6 million net of the $5.9 million in proxy contest expense accounts for about $0.09 per unit of the declined QFFO in the 9 months period. The additional items that had an unfavorable impact on FFO for both the third quarter and 9 months year-to-date period include foreign exchange losses as well as income tax expense, offset by lower G&A expense and lower interest expense. Again, each of these factors that impact FFO are detailed in our MD&A on Page 16 of the financial report.

Turning to the balance sheet for a moment. As at the quarter-end September 30, 2017, the IFRS value of our investment property portfolio was $275 billion, implying an overall cap rate of 8.1%. That is substantially unchanged from the prior quarter. Our income-producing portfolio of 92 properties comprised 30.2 million square feet having occupancy of 98.4% by GLA, a weighted average lease term of 6.6 years as measured by square feet as well as 75% Magna tenanted revenue or 69% measured by the GLA. Also at the quarter-end, our total debt stood at $692 million, was comprised only of unsecured debt, had a weighted term maturity of 5.2 years, a weighted average interest cost of 2.53% and a corresponding total leverage of 25%. And net of the $191 million of cash, cash equivalents our net leverage stood at 18%. Our credit facility, which is $250 million was undrawn, and our investment portfolio continues to be entirely unencumbered by any secured debt. Annualized distributions for the remainder of 2017 are expected to be $2.60 per unit based on the current monthly distribution of $0.217 per unit. And these will increase, as Mike mentioned, 4.6% to an annualized amount of $2.72 per unit or $0.227 per unit for 2018.

Lastly, for the quarter, FFO and AFFO payouts, adjusting for the lease termination fees and closeout costs, were 79% and 80% versus 68% and 69%, respectively, for the prior year period. For the 9 months year-to-date, AFFO -- sorry, FFO and AFFO payout ratios adjusted again for the lease termination fees and closeout costs as well as proxy contest costs were each 79% versus 69% and 70%, respectively, for the prior year period.

Total purchases made pursuant to our [incent] program from the inception of such program up to and including yesterday, November 7, were 212,000 units for a total consideration of $10.6 million, which equates to an average price of $49.93 per unit. And with that, I'll turn the call back to Mike.

Thank you, Ilias. Lorne just pointed out to me that down I've talked to the hand and that I'd said $14 million of landlord work and leasing commissions, it's really $4 million. So in case anybody picked up my mistake there. Operator, with that, let's turn it over to questions.

(Operator Instructions) Our first question comes from the line of Mark Rothschild with Canaccord.

I realize you can't get into specifics on new acquisitions, but can we talk about the types of deals you're seeing in the pipeline and which market should we expect you to be most active in?

The markets, yes, Mark, I think you'll see us most active in is the U.S. at this time. And we're seeing in there larger portfolios where some of the big pension funds or real estate players are selling significant pieces of their portfolios. And some of it's -- we're not seeing the type of stuff that we'd really like. it's hard to find, call it, high-quality product. But the type of deal that we just did with IDI is a type of thing that we like, that we look for and that's where we're going to continue to pursue.

And should I expect that, while do you have cash, additional financing would come from maybe the unsecured bond market?

Yes.

Okay. And then my only other question, I'm not sure if you disclosed in the past, the lease rate for the new lease in Michigan?

Sorry, the lease rate?

Yes. The rent rate.

The rent rate, 1450.

Our next question comes from the line of Sam Damiani with TD Securities.

With regard to the 2018 expiries, it looks like a little over 20% of the expiries have already sort of given notice to vacate, not renew, a little more than I was thinking coming out of the second quarter. Just wondering if you could give some guidance as to what we should expect for 2018 in terms of retention?

In the ones that said they're are not going to renew, Sam, the -- 2 of those were looking to actually sell. One is Tilsonburg, that I mentioned. And one other one is a large one that we had in Botlek in the Netherlands. It accounts for over 300,000 square feet, which we're quite comfortable with. There's another one in the GTA for about 150,000 square feet, also very comfortable in terms of its releasability. So it's not as grim as you might have anticipated.

Not meaning to sound grim, but again, just a sort of -- as we look at the balance of the maturities that haven't yet been addressed, how should we think about the retention rate on those leases as discussions take place, I guess, Magna's going to give notice by year-end, is that right?

No, not by this year-end, no. They're usually 6 months and a lot of them are at the back-end. So we get 6 months notice on a lot of them, it's not always a full one year notice. And some of those that are coming up are -- they relate to New Park, which we've listed for sale. And on balance, we feel pretty comfortable with the retention of the rest of the portfolio.

Sorry, Siemens is a 2018 expiry, I thought it was a longer term than that?

No, Siemens was-- they had an early break option. And they exercised their early REIT termination rate to terminate that lease in July 2018.

August, August.

2018.

And just looking at leverage with the acquisition in October would the pro forma net debt leverage be around 22% today, is that about right?

It would increase, Sam, as Mike mentioned we did draw on our line temporarily. It would increase by about 3%-ish but that will be in large part reduced as we repatriate capital from Europe, as Mike mentioned.

Right, but on a net debt basis, it would go up about 4%, 5%, I think, right?

No, it would be about 3 percentage points.

Okay. On the NCIB, is there any reason we should expect the pace to change from the, sort of the $10 million you bought over the last few months?

The pace is likely to be the same. The part that is uncontrollable at times is availability both in terms of the price and certainly in the blackout period, it's out of our hands. If you understand what I mean, i.e., we don't have discretion during blackout. There are specific instructions, and those are executed and is a function of what is available. So the intent, however, is to nibble around the edges. We've always said that, and I think, Mike has been consistent with that. And we plan to continue to do so and be opportunistic in doing so.

Okay. And just finally one more, and I'll turn it back. On the IDI acquisition, are there any near-term leasing issues or requirements that might arise.

We have one vacancy at -- in October of 2018 that we know about. And certainly, through -- and we have been actively negotiating with a prospective tenant. Actually, we're doing that through diligence. We're in advanced negotiations on that and started that as a part of the due diligence of the acquisition. So nothing to report on that yet. But that's the only one of substance.

How much of the that acquisition would that one lease or one space represent?

700,000 square feet is that. And it's in the, we call it the Memphis building, which is in the Mississippi it's just outside of Memphis.

But I didn't hear the square footage.

700,000.

700,000.

Our next question comes from the line of Troy MacLean with BMO Capital Markets.

Just given how competitive the acquisition market is, would it be fair to say that development could become a bigger focus in the next year or 2?

Become a bigger focus? Development has always been on our radar. We've got a couple of opportunities. I mentioned the Poland one that we're looking at. We still have potentially another 250,000 to 275,000 square feet of development opportunity there. But as I said, we'll look to make sure we've got that preleased before we start to build. But development in terms of an allocation of capital, we'll absolutely look at that. But the development yields on the development just aren't what they were so we're going to be careful about that. And the other redevelopment, as I mentioned, is also potentially Altbach.

And so on the development yield, was that in Poland, specifically? Or is that just a general comment on the market overall?

Generally, particularly, in the U.S., Troy. Seeing the development yield there. The spreads over, which you can probably get 75- basis points to 50- basis points from just a straight buy.

That's good color. And then just on the G&A, it came down quarter-over-quarter. Is the Q3 level a good run rate for how we should think about Q4 and 2018? And will there be any onetime search costs in the kind of the near-term G&A?

There'll probably be a little -- some search costs. I'm hard to replace -- no I'm joking. But there will be some near-term costs associated with that, Troy. And from a run rate perspective, yes, the 5.7 overall to 6 is not a bad run rate as we sort of indicated before. We're working to, as I said, continually drive that down.

If I may, Mike -- Troy, I would add that in light of the acquisition that we did, one of the things that we had said I think on previous calls is that our business is scalable. We don't anticipate to incur material G&A as it relates to that particular acquisition. So in that regard, now it's kind of we've made an acquisition, we don't expect any addition as a result of it. Then, in addition to the comments that Mike made.

Our next question comes from the line of Howard Leung with Veritas Investment Research.

Just want to touch on the IDI acquisition there. How much of that was funded using cash, and just approximately how much was debt?

Yes, the bulk of it was cash and right now $93 million in terms of what was the draw on the facility out of the gate and that over time will be drawn -- will be paid to 0 by, I'll say, early 2018. Because as I mentioned, we've got -- we'll be repatriating the cash from Europe to, to pay that facility down.

Okay. So that will be back -- to 2018. Just going to -- want to go into NCIB a little bit. The buybacks were kind of at the price of almost $50.00 a unit. How do you think about the level in which you're willing to buy back units when kind of your NAV right now is around $48.00.

Yes. I think you've seen just by how we've been buying in the price levels, that gives you the indication in terms of what we're -- how we think of it. I don't want to say anything much more beyond that.

Okay. The vacancies in Canada and U.S., I understand, there are a couple of renewals this quarter where the rates were lower than last year. Just kind of how should we should think about these renewals for 2018? Do you see the rates that you're getting now to potentially lower, as you renew?

No. It's going to be situational, Howard. For example, the ones that we actually have renewed, the ones what I mentioned of 1.1 million square feet, those have been -- we expect some rental increase on there. And usually, it's subject to the market at that point in time. But we do see some uptick in the rent for those particular properties and often those discussions can turn into term -- additional term, depending. But overall, in terms of the balance of rest, we don't see any significant -- any declines on that front and perhaps opportunities for some increases, depending.

Okay. The last one is about just distribution increases. So this time the increase was about 4%, 4.5%, the year before was like an 8% increase. Just want to know your thoughts on the pace of the increases, whether -- were you saving kind of firepower for acquisitions or buybacks?

No, I don't think so. It was the -- as we overall sort of consistently said, our payout ratio on FFO basis is somewhere between 70% and 75%. If you look historically before last year, we were under 70%. So might call last year a little bit -- the boot to 2.60 a bit of a catch-up. And this year's increase of 4.6% and is also, I think, a bit of a show of confidence from our perspective in terms of, certainly, the additional FFO generated from the IDI, from Novi relative to this year plus potential for further increases next year as hopefully we deploy the balance sheet.

Our next question comes from the line of Pammi Bir with Scotiabank.

Mike, what would you sort of consider a good year for acquisitions in 2018? And can you comment on perhaps how much is currently under review?

In terms of what's under review, we've got in the quarter, I'd say, we looked at over $2 billion of potential opportunities. In terms of what's currently under review now, it's -- we've got a fair bit. I can't give you sort of the specific number. And what was the first part of your question, Pammi. Sorry, I just lost it. Oh, what do you think a good -- as we've said, we're looking to accelerate the deployment of the balance sheet for -- in 2018 and beyond. What would be a fantastic outcome if we could deploy a substantial portion of the balance sheet next year and that's what we're going to try and work towards.

So sorry, when you say a substantial portion and working towards that next year, I mean, so basically, you're saying effectively a fantastic year would be if you can basically buy a billion dollars of assets, roughly?

That would be an unbelievable year. Yes. And that's how I would characterize it. But I just want to make the point that we're committed to deploy the balance sheet. We want to accelerate the growth, and we're scouring our markets to make that happen.

Okay. And just going back to your comments on the 2018 and the comments around leasing. How do you see occupancy shaping up by the end of the year? And what sort of internal growth or same-property NOI growth would you expect to deliver?

Lorne, any thoughts on that?

I think, we've already kind of given you some color on the future vacancies that are coming up Mike gave you in the call. The balance of the properties, it's a little too early to tell. I will say that within the remaining properties, there are 5 additional new park properties that are part of the listing that's currently out there on those. So there are 5. If that works through, that will come off that list as well, but a little early to tell. The rest of them, we're working hard on. We've nothing specifically that we have any information that suggests they're leaving, but it's still too early to tell at this point.

On the increase bonding, we see opportunities for rental increases. We've got some of the big 17s that expire, that have got to get renewed some bumps coming on those in 2018 that you'll see in the -- for year-over-year. It's early days yet, but I don't think we're looking at declines on that from overall.

Okay. That's helpful. Just lastly for me. On the properties that are being marketed for sale, what's the IFRS value and your thoughts on potential timing?

I don't want to give any hints on what the current IFRS is, it's why I sort of refer to just the revenues being generated. And we've got offered the -- the offers are expected for both those properties in the near term, imminently. So we'll have some color on that within the month.

(Operator Instructions) Our next question is a follow-up question from the line of Sam Damiani with TD Securities.

Most of my questions have been asked, but I just wanted to see if you'd be willing to share the list price of the properties listed for sale in the new market?

There isn't a list price on there. No list.

No?

Yes.

And who is the broker marketing the package?

CBRE.

CBRE?

Yes. Just to give you further color on that, it's about 45 acres there of contiguous property and over 500,000 square feet of space.

Our next question comes from the line of Neil Downey with RBC Capital Markets.

And Mike, you just answered 1 of my questions, which was the total acreage in new markets. But just to follow-on in that regard. I believe, you said that 9-acre parcel is also listed for sale and that Magna pays rent on that today, is that right?

That's right. It was for expansion possibilities, Neil, that's...

Walk or drive?

Correct.

So this it's beside the cosma facility on (inaudible).

Correct.

So what's that worth, like a million an acre?

I think, it's substantially more than that. I'd say it could be 1.5 million to 2 million an acre, Neil.

Okay. And that's classified as an income-producing asset, not your $7 million of land for development on your balance sheet, right?

Correct.

Okay. Circling back to clarify on Novi, Michigan. I think, did I hear you say, generates revenue as of January 2018?

Yes.

So that will be straight line revenue, not cash revenue?

That's correct.

And cash rent, maybe by the middle of the year?

The -- I can't remember that. I think, it's less than 8 months -- I'd say by -- -- into the second quarter will be cash revenue, Neil.

End of the second quarter, so it's about mid-year.

I mean, when we're in the second quarter, we'll get cash rent.

(Operator Instructions) There are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Thank you, operator. In closing, I would like to just thank all of our employees for their help and contribution to making this solid quarter happen. And with that, from here, we'll sign off. And thanks very much, everyone. 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.