Automotive Properties Real Estate Investment Trust (APRUN) Earnings Call Transcript & Summary

Good morning. Welcome to the Automotive Properties REIT 2022 First Quarter Financial Results Conference Call and Webcast. My name is Dennis, and I'll be your conference operator today. [Operator Instructions] Please be aware that certain information discussed today may be forward-looking in nature. Such forward-looking information reflects the REIT's current views with respect to future events. Any such information is subject to risks, uncertainties and assumptions that could cause actual results to differ materially from those projected in the forward-looking information. For more information on the risks, uncertainties and assumptions relating to forward-looking information, please refer to the REIT's latest MD&A and annual information form, which are available on SEDAR. Management may also refer to certain non-IFRS financial measures. Although, the REIT believes these measures provide useful supplemental information about financial performance. They are not recognized measures and do not have standardized meanings under IFRS. Again, please refer to the REIT's latest MD&A for additional information regarding non-IFRS financial measures. This call is being recorded on Friday, May 13th, 2022. I would now like to turn the conference over to Milton Lamb. Please go ahead, Mr. Lamb.

Great. Thank you, Dennis. Good morning, everyone, and thank you for joining us today. With me on today's call is Andrew Kalra, our Chief Financial Officer. We continue to generate year-over-year growth in our key performance measures in the quarter. In comparison to Q1 of last year, our property rental revenue grew at 5.3%, cash NOI increased by 5.4%, same property cash NOI was up 2.5% and AFFO per unit diluted increased to $0.228 up from $0.227. Our acquisition program is off to a strong start in '22, as we deployed $65 million on acquisitions in the quarter, including the acquisition of 2 Honda dealership properties in Quebec, the acquisition of approximately 2.2 acres of land, underlying our Langley Acura automotive dealership property in Langley, B.C. We also purchased a parcel land joining the Bank Street Toyota dealership property in Ottawa. And finally, we increased our EV exposure through adding additional Tesla automotive service center properties, 1 located near Barrie, Ontario and 2 adjoining properties in Quebec City, increasing the number of Tesla automotive service center properties in our portfolio to 6, representing 9% of the REIT's portfolios GLA. The capitalization and discount rates applicable to our portfolio remain consistent in all regions compared to year-end 2021, with a slight overall decrease to 6.25% at quarter end, down from 6.3%, primarily attributable to our purchase of the Acura -- Langley Acura land. In April, we successfully extended one of our credit facilities to 2027 and increased the non-revolving portion to $226.3 million, retaining the same credit spread. Andrew will provide more details on this shortly. Our liquidity position remains strong, as we currently have $80 million of undrawn credit facilities and 10 unencumbered properties with an aggregate value of approximately $121 million. At quarter end, our debt to GBV ratio remains at 41.6%, and we remain positive -- sorry, well positioned to deploy capital on growth opportunities. The fundamentals of the automotive retail industry remains strong. According to Stats Canada, new automobile sales in Canada for 2021 increased to 6.8% compared to 2020. According to DesRosiers Automotive Consultants, new light vehicle unit sales were down 12.1% in Q1 of this year compared to Q1 of last year, which is primarily due to the supply chain constraints experienced within the retail automotive industry. We believe these supply constraints will continue into the foreseeable future, but will not have a significant impact on our tenant's ability to pay rent, as new car margins, used car sales, and overall service levels remain strong. Industry margins continue to remain healthy. I'd now like to turn it over to Andrew Kalra to review our financial results and position in more detail. Andrew?

Thanks, Lamb, and good morning, everyone. Our property rental revenue for the first quarter totaled $20.4 million, a 5.3% increase from Q1, 2021 reflects growth from properties acquired during and subsequent to Q1 last year and contractual annual rent increases. Total cash NOI and same property cash NOI for the quarter totaled 16.9 and $15.8 million respectively, reflecting an increase of 5.4% and 2.5% compared to Q1 a year ago. Growth in cash NOI was primarily attributable to acquisitions and contractual rent increases, growth in same property cash NOI primarily reflects contractual rent increases across our portfolio. G&A expenses for the quarter were up approximately $140,000 in line with our expectations and growth. Net income for the quarter was $29.7 million, an increase of 12.8% compared to $26.3 million in Q1 last year. The positive variance was primarily due to higher NOI and non-cash fair value adjustments for interest rate swaps, investment properties, Class B LP units and unit-based compensation. FFO and AFFO for the quarter increased by 2.5% and 2.7%, respectively, compared to Q1 last year. FFO per unit diluted was $0.24 in the quarter compared to $0.239 in Q1 a year ago. And AFFO per unit diluted was $0.228 compared to $0.227 in Q1 a year ago. This growth was primarily due to properties acquired during and subsequent to Q1 a year ago and contractual rent increases. We paid total distributions of $9.85 million or $0.201 per unit in the quarter, representing an AFFO payout ratio of 88.2%. This compares to total distributions paid of $9.6 million or [ $0.211 ] per unit in Q1 last year, representing an AFFO payout ratio of 88.5%. The AFFO payout ratio was lower this year primarily due to properties acquired during and subsequent to Q1 a year ago and contractual rent increases. We had $454.4 million of outstanding debt, as at March 31st, 2022, with an effective weighted average interest rate of 3.71%. We have a well-balanced level of annual maturities, and our weighted average interest rate swap and mortgage term is 5.7 -- 5.1 years, with a weighted average term to maturity of debt of 2.6 years. As Milton mentioned earlier, subsequent to quarter end, we extended the maturity of facility 1 for a 5-year term to June 2027 with the same credit spread and increased the amount available under the non-revolving component of the facility by $50 million. Immediately thereafter, we completed $40 million of swaps for an average term of 8.5 years at a blended rate of 4.75%. We continue to have strong support from our lenders. I'd like to turn the call back to Lamb for closing remarks. Thank you very much.

Great. Thank you, Andrew. As a result of rising inflation due to various factors occurring globally, the Bank of Canada recently raised the overnight rate by 50 basis points with further rate hikes expected over the remainder of the year. We've consistently completed longer-term swaps or mortgages to insulate our existing debt from future interest increases. We continue to monitor the impact of this rising rate environment and inflation on our property portfolio and the overall real estate industry. With contractual rent increases consisting of a mix of CPI adjustments and set annual rent increases in our portfolio, as reflected by the 2.5% same property NOI increase in Q1. Given our strong balance sheet position and the strength of our existing portfolio, we will continue to pursue acquisitions on a strategic basis. This now concludes our remarks. Now, I would like to open the line for questions. Dennis, please go ahead.

[Operator Instructions] The first question comes from [ Frank Liu ] with BMO Capital Markets.

Just -- so my first question, just looking at your maturities, it's definitely great to see the expansion on the credit facility and the [ $50 million ] of financing. But looking at mortgage maturities in the -- in the near term, let's call it 2022 and 2023, I see about like 57% of that -- like mortgage maturing in the next 2 years. Just wondering if you can provide some color on the...

So -- yes, I was actually hoping for some color. What is -- what was your -- what kind of mortgages are you seeing rolling over in the next 2 years?

Like 50% is that...

I'm sorry, I don't recognize that number, sorry.

Yes, that's -- that I mean, we just -- that's approximately 50% that we just renewed for 5 years. So that may be true for Q1, but that does not include the subsequent event of April. We have very little exposure to interest rate fluctuations over the next 2 years because we're mostly long dated.

Yes. I think you're looking at just the Q1 result and not looking at the subsequent event and what we just stated in the call right now with regards to the extension of the credit facility.

Okay. Yes. Sorry, I missed that. But...

Yes. Certainly, why we wanted to get it done, and why we've always been longer term in our durations because it's hard to maintain interest rates that we saw in 2020 and '21.

Okay. Yes. Yes, I appreciate the color. Sorry I missed that part [ at the beginning ]. But look -- yes, but like looking -- just going back to the acquisition side of things, and I mean, acquisitions has like pickup like [ thus far ] in 2022. I guess like how should we think about the pipeline throughout the year? Does the rising interest rate have any impact on the pricing when you're looking at like new deals?

But I think...

Naturally, it has to. So I'll answer both parts of that question, which is we tend to do more in the back half of the year, early in the year. OEMs are taking their time right now in approving M&A. And as you know, we kind of track a lot of the M&A activity to provide opportunities. But really, what we saw and one of the reasons why we did not do as many deals in '21 than we would traditionally have done is because there was a bit of euphoria and the cost of capital for the dealership community through banks and financial institutions was incredibly low. So the good news is that -- the level of cap rates did not go down, as much in this category, as it would have potentially in other sectors. So we do have a bit of a buffer. But certainly, as we're looking at new acquisitions, we underwrite those acquisitions based on the current interest rate environment. And as -- as just mentioned, we're insulated on our existing portfolio. So I think any time you see this much movement of interest rates, there tends to be a drag between the buy, sell and that gap will go on for 6 months, 9 months until buyers and vendors kind of meet the new reality of the new interest rates. So in short, we certainly do believe that it's part of our equation, it's part of everyone's equation. But last time, we saw an interest rate increase is actually when we saw activity increase for us because if dealers in the general community have a 0 cost of capital, that's tough to beat, whereas if there is a real cost of capital with slightly higher interest rates, it allows us to underwrite and allows them more options on the table, and that tends to allow us to get more deals done.

Okay. That's great to hear the color. But maybe switching gears to the demand side for autos. I mean like the sales was down like 12.7% year-over-year in Q1 and you mentioned the decline was mostly due to like supply constraints. I wonder, looking forward, do you think the demand like from the -- like the consumer demand would be lower throughout 2022, like due to the -- I guess, people always have some concern about the gas price, like with some customers just like shy away from higher gas price?

Yes. I think gas price tends to be more on what type of vehicle you buy, do you buy a large Ford F-150 or do you buy a Honda Accord. So it can change some behavior. We're not worried about the car sales on the demand side. It's more on the supply side. And the opposite to that is just the fact that because there's constraints on supply, the margins and the preorders are very healthy. So we certainly don't see this being a significant negative effect for the dealership community. Certainly, you're talking about what levels of high profits, as opposed to profits, which gives us very strong comfort. But it does -- the drop in sales is not a demand drop in sales. It's a supply drop in sales.

Okay. Yes. Maybe following up on the supply side. Have you heard any improvement on the supply side from dealerships? Or is this going to be like a 1-year or 2-year problem, [ where if you're ] looking forward?

Sure. It really depends on the brand. Some of them are talking about getting more availability in the next 2, 3, 6 months and other ones are talking about it being a bit longer than that. So it does depend on the brand because as you can imagine, the supply side equations are more global equations, and there's a significant amount of components that go into each car. But they're certainly on top of it. We think you'll still be supplied -- supply side constraint in '22. The question is when in '23 and '24, does that change and global events keep on changing. And so, it's really hard to predict.

I see. Yes. I guess, like, it was that kind of outlook on the supply side. I guess, the used car sales will continue to be strong in the -- I guess, in the near term.

They were incredibly strong. It's hard to be record over record after record. But I certainly believe that they will remain strong.

Perfect. So just one last question from me. So also on the rising gas price, where it's -- all of its [indiscernible] we don't know, where the price is going to come to. But I wonder, interesting to hear your thoughts on that like does the like rising gas price, would you expect to get more exposure towards EV dealership and service center versus traditional car dealership like Honda, Toyota, [ are leaning ] more towards right now, Tesla or some other new brands that just coming to the market?

I certainly believe the evolution is going to bring new brands. Tesla is certainly profitable. And we have done a number with them and certainly like them. But I think that evolution also goes to the Honda's, Toyota's, GM Sports. They're including significant EVs in their portfolios. They're rolling out now and certainly will be rolling out over the next couple of years. I think that will be certainly part of what happens going forward, and we certainly like that. I mean, we continue to be part of that evolution and look forward to as the industry changes. I think that provides us some good opportunities.

I mean, just -- sorry, just to follow-up on that one last question. I mean with those traditional car manufacturers introducing more EVs or HPV, whatever is so-called, does that require some CapEx on the lender -- sorry, from the landlord perspective in terms of those new EVs, do they need additional infrastructure for like maintenance work?

Not to the point, where the dealer would be approaching APR at this point. That normally would be self-funded.

Your next question comes from Mark Rothschild with Canaccord Genuity.

I only have a couple. Maybe just generally on the impact of what's going on, whether it was with inflation or interest rates, do you expect to see any dealers or maybe automotive dealership owners face any distress or maybe look at things differently going forward? Or is this maybe just more positive. I'm just curious how you see this evolving in regards to deal flow in general? And even if you haven't seen anything yet, what's your best guess?

Yes. I mean the interesting part is the model has slightly changed because of the supply side constraints, whether it's COVID, Ukraine, et cetera, and it's become more of an order model as opposed to put inventory on the lot. So their interest rate exposure is down because they're not maintaining as much inventory, as they traditionally were. We're hearing numbers anywhere between 15% to 30% of traditional floor plan financing out there. And that's where they would feel the interest rates a bit more. The interest rates can potentially affect some of the consumer side on demand, and again, similar to the gas prices that may affect the consumer behavior. Do they go -- does that change their budget on what they want to spend on a car because a lot of consumers look at monthly payments. So all of that may change. I'm not looking at that being flowing through to distress on the dealership retail community. Now, we're not seeing that nor are we expecting it certainly in the short term, short to mid term.

Okay. Great. That's helpful. Maybe just one more. It's great to have the debt taken care of. But are you -- and maybe you're not looking at this because you're not in the market today, but are you seeing any change in the credit spreads on financing your type of properties separate from moves in interest rates?

[indiscernible] type of property, but I would say overall that, yes, you're seeing a bit of a push out on spreads, and this is not surprising. Saw it in 2008, 2009, saw it in 2017, '18. As rates go up and the expectations of further rate increases occur, you'll see spreads push out a bit and then pull back. So there's a natural pendulum that does occur. So nothing there is really surprising us. And certainly, we're in a good place on our existing debt. And when we're looking at new acquisitions, it's formulaic as far as where we're comfortable doing deals. So it becomes part of our equation.

Your next question comes from Jonathan Kelcher with TD Securities.

Sorry, I'm just going to jump back on Mark's question for one second. I mean it's -- it was -- it's important to note that the spread, we've been able to maintain that since IPO, including the last round. So we certainly, on our credit facilities, expect that to remain very consistent. Sorry, Jonathan, I interrupted you, go ahead.

I know you, that was my question. The actual question is on the -- on the floating to fix, it does go out past the term of the debt. Do you -- like if you -- if credit spreads did widened, is there anything that impacts the fixed rate.

If credit spreads do impact us? So I guess, you're talking in detail with the swaps. And if you look at the swaps, and you look at the [ laddering ], we're well insulated over the next 2 and a bit years on any kind of maturity. And those would be the ones that would go from a fix to a float. So over the next 2 years, we're well positioned. And then we're monitoring as we go, as we always do, and we extend -- accordingly blend and extend those swaps.

And in addition to that, Jonathan, what you're also talking about is our credit facility spread, and we just renewed 2 of them for a significant portion of our portfolio, and that's remained consistent. So we certainly believe that we're going to carry on.

And the $50 million increase, you said $40 million of it, you already...

$40 million of it, we put into swaps, and $10 million at floating at this point in time.

So $10 million -- so you've got net $10 million more of floating right now, right?

Correct. That's correct. Correct.

Okay. And then secondly, on the CPI increases. What's -- I'd assume that they're annually on a look-back basis, what's the sort of cadence in terms of quarters for those various leases?

It varies because it's based on the timing of the acquisitions. So on the bulk of the 60% with Dilawri, that cadence would be at the time of the IPO would be July and August and the other ones would -- the remaining 40% would be across the board.

Okay. So we just go look that up.

[Operator Instructions] Your next question comes from Sairam Srinivas with Cormark Securities.

My -- most of my questions have already been answered to -- I mean, to the prior comments on the call. I just wanted to pick your brains on the AutoCanada announcement that came out earlier this month, as well as their broader strategic initiatives on acquisitions over the next 5 years. I was wondering, if the deal -- the [ Porsche ] dealerships at the Arcadis is something that crossed your line and in terms of partnership opportunities, either with AutoCanada or with others you're seeing out there like, are you seeing any of those come through?

When cost of debt was what it was in '20 and '21, especially in '21, that has an effect. Certainly, going forward, the capital availability and the cost that you've seen over the last 18 months will change. We are still seeing and having good conversations. I find that it's not an all or nothing game with most of the dealership groups. There's times when they want to talk to us and do deals, and other times when they want to keep it on their own book, and we're okay with that. That's -- it was certainly -- we don't live in the all or nothing world.

That makes sense. And guys, in case of the Bank Street acquisition you guys completed in Feb, what's the thought process behind that land parcel there? Is it like, do you guys think like, I know it's currently leased to a health care provider, but is -- are there any talks of like developing that? Or like how do you see that going?

That land piece is just -- it was -- I mean, I would say, it's a joining, but it was kind of partially in the middle of. And it just doesn't make sense to own that much of a block and have a sliver that you don't own. So it came available. You never know what happens long term. But the amount we paid for it, if there is a development in the long term, that's going to be -- we paid less than the shoring costs, never mind the setbacks and easements. So that is -- we're earning some income on it, but that is just a pure real estate decision that you really don't want a chunk of land for that amount of money kind of [ jading ] into a significant land parcel that has a long-term lease. So we're not expecting that to be something that crops up immediately. But it's one of those things that when you want to do it and you need to do it, you get held hostage. So when it comes available, if it's not a significant number, it's the right thing to do on a real estate basis.

Your next question comes from Scott Fromson with CIBC.

Just a question on inflation. Most of my questions have been asked already. Where do you see the impact of inflation on the operating cost structure versus the rent escalators?

In terms of G&A, we've got, obviously, our human capital, and then, we've got a very light infrastructure. So I don't anticipate a significant amount of increase in -- from inflation on those costs. So the rent escalators would be covering those [ this way fully. ]

Yes. And we've got our office lease, which we renewed recently and are now expecting that won't get affected by inflation either. So we're -- on G&A, we're pretty buffered. I mean, remember, we're a non-operating type group. So that those operating costs and flow throughs will -- are on the tenants' responsibility world, not ours.

Your next question comes from Himanshu Gupta with Scotiabank.

So the same property cash NOI up 2.5%, pretty nice. They're higher than recent quarters. Is that the new run rate for this year now?

No, it's difficult to put a run rate. We don't really provide forward-looking information. But what I've said before is that 60% of our portfolio is at [ 1.5 ] and the remaining is a mix based on inflation. Also, we've had some renegotiation of a lease, which contributed to that as well. So it's difficult to say where the run rate is going to be. Sorry, we don't provide that information out. But with the 40% out of mix, inflation is definitely going to impact that, and that's going to result in same property at a higher percentage.

Got it. And when you said renegotiation, does that mean...

Yes. [ That's a ] renewal, that was in May of 2021. So that was a renewal.

That was a renewal.

Okay. Okay. Not -- I almost [ thought ] renegotiation.

Sorry, I must say, that's a renewal. That's a renewal. Yes.

Okay. Okay. That's fair enough. Okay. And then back to the acquisition capacity questions. So $80 million undrawn credit facility, does that include the increase in $50 million, which was done in April?

Yes. I guess. So it depends how you look at that. We took that $50 million, and we obviously did the swaps in the long term. So what's outstanding right now in our available floating -- not floating, sorry, our available non-revolver is $80 million.

$80 million. And then the unencumbered asset pool, I think you said something like $121 million. So how much debt you can actually put on that?

We tend to be a bit conservative. But often, we'll do anywhere between 45% to 60% debt. And then we may leave other properties. We always like to have some properties that are unencumbered. So it's a balance. We don't mind levering up some properties, but not all them.

Okay. So basically, the acquisition capacity would be something around $140 million based on the existing credit facilities right now plus the unencumbered asset pool there. Okay.

Our math [ forward set ] to be a bit more than that, but you're not totally wrong.

Okay. Okay. And then have you explored conventional mortgages, like most of your debt sources are all credit facility. Any other sources of debt have you explored in this environment?

Yes. I mean we're always talking to different groups, and we did one last year. That was a long-term 10-year mortgage. It really depends on the type of asset. We do like having flexibility to pull properties in, to add 2 properties by that, I mean, expand them. So there is a lot of flexibility and maybe that's because the years I spent actually doing real estate deals. The cost of defeasement and various constraints really can tie your hands in a portfolio. But there's going to be some assets on our book that are very long term, they're going to be what they are. And so in those assets, we're comfortable putting some mortgages in place.

Okay. Got it. And then the final question is on fix versus floating, so it's more of a clarification. So you have swaps in place for the next 2 years. So it's all going to be fixed. And I guess when the facility 2 comes for renewal, that time, you will have to readdress the swap on it. Is that how should we feel it?

No, Andrew, go ahead.

Yes. Let's -- we clarify that. Sorry, we've got swaps [ that ladder ], all the way up to [ 4.9 ] average and they go from 3 to, let's say 2 to 10 year out. Now when facility 2 does come up, those swaps will continue to keep their existing maturities, so they just will flow through.

Yes. We've always had swaps a longer duration than a lot of our credit facilities. So they are certainly not matched to the term of the credit facilities.

Okay. Okay. So then the swap on facility 2 is beyond [ the term ], which is, I think, in 2024. Okay.

1, 2 and 3, all of them have swaps beyond the term of the credit facilities.

Your next question comes from Kyle Stanley with Desjardins Capital Markets.

You spoke about the impact of rising rates and the lag effect that sometimes has on the M&A environment. I'm just wondering, in addition to that, are you seeing dealer groups really holding out -- waiting for the supply side issues to abate before maybe considering a sale?

It's interesting, you are [ seeing ] the supply side constraints there, I'm actually hearing it from the other side, which is they're loving to run it while they're getting the margins that they're getting. It depends if -- it's more important to you to have revenue or more important to you to have higher profits. If you like higher profits, it's a pretty nice time to be a dealer, if you're just focused on revenues, additional supply will help. So we are certainly hearing from the -- both -- more from the buy side because that's who we talk to more that there continues to be dealers that may look at selling in the future, but are enjoying the profits right now, so we are in no rush. But everyone is looking ahead on -- there's no such thing, as I always say, it's tough to be the most improved player 3 years in a row. So record profits are very good. But I think they are going to be in a good profit scenario going forward.

And then just one last one. As you look in the market for external growth opportunities, are you considering some -- anything outside of auto or service, whether that just be RV or some other type of dealership property?

Yes. I don't think it has to be pure dealership. We like automotive. RVs, we tend to like urban markets, suburban markets, metropolitan markets. And most of the RVs tend to be a bit further afield. That doesn't mean, there may not be a couple of examples that make sense, but a lot of them tend to be in areas that don't have the same sort of land supply side constraints that we normally like. But that doesn't mean truck dealerships, equipment dealerships, if opportunities came up in that will we look at it? Sure. Certainly, we've done stuff with Tesla directly with the OEM. I think there will be other opportunities than just pure dealership properties. I think the automotive and the mobility world continues to evolve, and we'll certainly look at that.

Thank you. There are no further questions at this time. Mr. Lamb, back over to you.

That's great. Thank you, everyone, for joining us. We look forward to talking to you after Q2. Enjoy the summer. Bye.

Ladies and gentlemen, this concludes your conference call for today. We thank your participating, and ask that you please disconnect your lines.