FIBRA Prologis (FIBRAPL14) Earnings Call Transcript & Summary

[Audio Gap] 1:40 p.m. session at Citi's 2020 Global Property CEO Conference. I'm André Mazini with Citi Research. And we're pleased to have with us here the CEOs of FIBRA Macquarie, FIBRA Prologis, Terrafina and Vesta. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available upon request and on the website. For those in the room or in the webcast, you can sign on to liveqa.com and enter code citi2020 to submit any questions you have or you can just raise your hand. Please do that. So Lorenzo Berho, Juan Monroy, Luis Gutiérrez, Alberto Chretin, we turn it over to you to introduce you and your company and management team, and provide the audience 3 reasons why investors should buy your stock today, and then we'll begin with Q&A. So maybe starting with Loren on my left.

Perfect. Thank you very much, André. It's always a pleasure to be in this panel every year, and I'm glad to see very good friends. We are -- Vesta is a company, which was listed in the Mexican Stock Exchange in 2012. We have more than 20 years developing industrial and logistic real estate throughout Mexico, mostly focused towards light manufacturing sector as well as logistics. We're basically in the most dynamic markets of the country, mostly Juan -- Juarez, the Bajío region and the proximity of Mexico City. We currently hold over 30 million square feet of assets, mostly in the logistics, aerospace, automotive, electronics and renewable energy sector. Our main focus is still developing industrial real estate more than acquisitions. We have been developing Vesta Parks where we acquire land, put the infrastructure in place and develop multi-phase projects in multi-tenant buildings, inspect buildings as well as build-to-suit projects, mostly catering the global companies that are entering the market. And 3 reasons on why buying the Vesta stock. We believe the manufacturing sector as well as logistics sector in Mexico has shown lots of resiliency. We have -- 85% of our income is in U.S. dollars. We have long-term leases, more than 5 years of weighted average lease expiration with investment-grade companies. So it's basically similar to buying a bunch of corporate bonds. That's one reason, the portfolio. Secondly is the opportunity for growth through development in accretive investments. Return on cost for development projects are above 10%, while stabilized assets currently in the Mexican market are trading at 7%. So we believe that this is some edge on value what -- we have the development capabilities. And thirdly, Vesta has firmly been having the strategy of focusing on profitability. Therefore, we've been also buying back shares. Even this morning, we've been buying back shares. We believe that at certain point, it's important for the company to find profitability. And this is a good use of capital allocation, and the profitability that we have been focusing on from a buyback program, the buyback program as well as the increase in FFO per share. Thank you, André.

Great. Alberto? Alberto, do you want to...

Thank you. Well, thank you, again, for your interest. Yes, Terrafina, we are a purely industrial FIBRA. We had the IPO back in 2013, and we started a company with a portfolio of about 19 million square feet. And during the last 6 years, we doubled the size of the portfolio. Right now, we have over 41 million square feet of properties. We are a dollarized company. 96% of our lease contracts are U.S. dollar-denominated. About 73% of our buildings are used for manufacturing for export and 27% for logistics and distribution. We have a very diverse portfolio in terms of geographical distribution as well as use of our facilities. Over 60% of our facilities are in the northern part of Mexico where all the manufacturing for export takes place. We have a very good position of our -- 20% of our portfolio in the in the Bajío market and then around Mexico City. We have a very good industrial park for about 6 million square feet where we did cater to logistics and distribution as well as e-commerce. Our portfolio also has had a very good record in terms of stability. I think if you let me go back about the reason why to invest in Terrafina, one of them is the stability. We have some of the best renewal rate of the expirations. We -- our average renewal of the expirations is above 90%. Actually, last quarter, we had 100% renewal of the expirations. Also the transparency, the corporate governance of Terrafina, in our opinion, is just the best in the industry. We do -- we are internally managed and externally advised by Prudential. But we have our Board of Directors, the ratio, over 70% is totally independent. And the transparency of the company is evident, as I mentioned, the stability, the continuity of the results, and thus the dividend yield. We have had a very stable NOI, and therefore, the AFFO has been also very stable, and the certainty about our distribution is evident. Also, in terms of the ESG, I'd like to comment on that because I think that ESG has been a very important part of Terrafina. We have had some of the best practice in terms of ESG with the assistance of our external adviser, Prudential. We adhere here very strictly to the FCPA. We also have an environmental risk management program, which we are able to evaluate in a sense the performance of our property managers. We do use certain indicators to make sure the -- how the stakeholders of Terrafina are adhering to some of these best practice in ESG. We -- this year, we're going to start with the RobecoSAM. And also, we have a training program on ESG where we have trained over 2,400 people altogether. In the social area also, we participate with our sponsor also in program, for example, [ Sorriendo ], in which we helped over 115 people that had some issues with the earthquake in Mexico City. This is something that if we do it out of conviction, I think that it's very important that now -- I think the investors and companies need to focus on this issue. And that I hope that the investors also acknowledge the benefit to -- that this has for the companies in order to be stable in the long run, and not only on the returns, which, by the way in Terrafina, are very good also.

Luis?

Thank you, and thanks for the invitation, André. It's great to be here. So FIBRA Prologis is a Class A portfolio of stabilized properties. These properties have been built the last 20 years, most of them organically. And basically, with the standards of Prologis' sponsor, Prologis is now the largest U.S. investor around the world. The portfolio is around 36 million feet. And hopefully, after the rights offering this week, we'll be 40 million feet, it's going to become the third largest FIBRA in there. Prologis owns 47%, so that aligns very much the interest of investors with the interest of the sponsor. We have 2 legs. One is manufacturing, it's around 1/3. And remanufacturing is one of the major drivers of the Mexican economy. And now with the Asian relocation, the -- Asia will be probably thinking about rebalancing their supply chains. And I think Mexico can be one of the winners. So that's a big driver. The other big driver is consumption and mainly e-commerce. E-commerce is now taking off. And one of our strategies is to participate in Mexico City. And I think that FIBRA has a great head start to the rest of the competition on this matter. As to what are the main things, why to buy Prologis. Certainly is the portfolio, as I just mentioned. The growth prospects internally. We have been having double-digit re-leasing spreads in the past several years and expect that to continue. And then on the external side, the exclusive rights of the FIBRA to buy the sponsors pipeline, it's a great competitive advantage. Today, the FIBRA has around $500 million of pipeline that it can acquire exclusively from the sponsor. And the third thing is, I guess, we have had the best total returns since our IPO in 2014, which is almost 15% since that time. On the ESG front, our sponsor Prologis is being recognized in the Davos World Economic Forum as the most -- or the top real estate, the most sustainable company. So we follow those best practices. Let me just mention a few. On the environmental side, our buildings are LEED, all of our new buildings. We have been recognized by BOMA, GRESB. And we're also included in the Dow Sustainability Index. We have programs like LightSmart in which we change the old to LED technology. And we are now beginning to install. During 2020, we have a solid program in which we'll start putting some solar panels and putting that electricity with our clients. On the social side, we have a labor relation, which is called Community Workforce Initiative, in which we train the neighborhood and we promote those people into our clients' labor. And then we also work with the charity programs within the communities that we participate. On the government -- governance side, we have a [ tail ] committee, which is mostly done by independent members. And certainly, the transparency is a practice that we bring from the corporate side out from the sponsor.

Juan?

Thanks, André. Thank you, Citi, for the invite. I'll be brief. Through Macquarie, we are primarily an industrial REIT focused on the key markets in Mexico. We owned 152 properties across all of the most important industrial markets. We have executed on a very profound transformation of the FIBRA primarily focused around asset quality. We have divested 44 of our properties selling at above book value and invest those proceeds in buying back our own shares. Fairly accretive transaction, pretty straightforward. Number two, we have delevered from 46% to 36%, have significantly enhanced corporate governance. I won't go into detail, but pretty profound transformation from that perspective as well. Have increased our customer focus, having an internal property administration platform with 80 real estate professionals across 10 offices around the country, really having the pulse of what's happening in each of the markets we operate. And through that platform, have been able to deliver significant enhancements to our operating and financial metrics. As of last year, Q4, we increased our AFFO by more than 8%. Ended up the year with an occupancy of 96 -- 95.6%, an increase of more than 120 basis points. Through to 2019, we increased our dividend by 11% and have given guidance for 2020 of a further increase of close to 7%. So a total increase of north of 17% in the 2019 and 2020 years. And we'll still maintain one of the lowest AFFO payout ratios in the industry, obviously, having a pretty prudent capital management investing on -- accretively for long-term value creation for our investors. Thank you, André.

So Loren, if you want to talk about the ESG initiative of Vesta. I think your colleagues talk a little bit on that. You talked mostly on the company. Do you want to talk about EGS?

Yes. Vesta has been working on ESG initiatives since 2011. Actually, we have an ESG director who oversees all of our ESG practices. First of all, in terms of governance, Vesta has 10 board members, out of which 8 are independent board members. We work with 6 operating committees, which are the ones that oversee most of the activities of the company, from submission to compensation to investment committees. So I think that, that's a very good to engage independent board members on the operating level. Vesta has recently -- has been adding, every time, more indexes to follow in ESG initiatives. Lately, we were awarded with Expansión business magazine as the #1 company in Mexico for ESG initiatives. Secondly, we were also a part -- we were included in the Dow Jones MILA Sustainability Index since 2019. And hopefully, for this year, we can also be in 2 more indexes, which is sustainability and another one so that investors can follow closely. In terms of environmental, Vesta has also several LEED-certified buildings. We have also developed a sustainability construction manual in order for all of the projects that we started construction and all of our vendors and contractors can follow-up on the same principles. And thirdly is that we measure in all of our industrial parks as well as with many of our tenants, all of the environmental emissions as well as consumptions. Vesta has also a sustainability committee, which every year approves a budget for the 17 social projects that we have overall in Mexico in [ 2 ] different states. For this year, we are approving $320,000 from Vesta. But of course, this also come together with many of our alliances that we might have in each of the projects in order to foster projects in lines of action of education, the community development as well as [ inclusion ].

Great. Thank you. I'll stop here and see if there's any questions from the audience? Anyone want to raise your hand? We do have questions here on the Q&A -- digital Q&A platform. So one of them, what is your outlook for the automotive industry in Mexico? What risk or upside do you see? So Juan, do you want to start with that?

Yes, happy to. Yes, the sales -- auto sales have declined generally. My view is the sector is still pretty strong. I'll say a few things. Number one, I think that the auto parts sector is perhaps more relevant last year. Auto part sales in Mexico were $98 billion. It's forecasted to grow to $103 billion. So pretty healthy growth. And I think over the medium term, looks as -- it still has plenty of legs, from my perspective, driven by the fact that with the ratified USMCA, the original content will increase from 62.5% to 75% to be produced in Canada, U.S. and Mexico. From my perspective, a good chunk of that increase will be further investment into Mexico. And also, I believe that with the U.S.-China trade tensions, I believe that global supply chain managers have identified as being too long-China in terms of their production capacity, and I believe that some of that diversification effort will go into Mexico. So I think that Mexico will benefit from those trends and the auto sector as well.

I'd like to complement. I totally agree with my friend, Juan. I think that in addition to that, I think it's important to acknowledge that the auto industry in North America is very simutized, regardless of these regulations and the fact that USMCA is being ratified, that it's going to be very good. But as I mentioned, regardless of that, the industry, automotive industry, we see North America needs each other in each 1 of the 3 countries. In addition to that, as we in Terrafina, we have our 30% of our manufacturing for export tenants are in the auto sector. We also wanted to gauge towards the level of involvement of our tenants in the electric cars, in the hybrid and self-driving cars. And we're able to confirm that most of them already have initiative to participate in this new wave of cars. Certainly, we're also very fortunate in Terrafina that one of our board members is the president of the -- former president of the Mexican automotive industry. And we keep a very close eye on how -- what's happening with the auto industry. And that the fact that these electric cars, hybrid cars and the self-driving cars, it's something that is going to happen sooner than what we think. And a lot of our tenants are involved in these kind of initiatives. So that's why we are -- we continue to be bullish on manufacturing for export. We think that the fundamentals of Mexico for manufacturing for export continue to be very strong. Companies in -- operating in Mexico on this fashion, especially the auto industry, have been very successful with their operation. They reached their quarterly goals, their productivity goals, and certainly, the cost.

Loren and Luis, want to add something on that, on the car manufacturing side or pretty much said? Okay. Some more questions here. So what could be the impact on your companies if coronavirus continues to affect supply chains around the globe? Do you have any contingency plan given the recent news around Mexico?

Well, so Mexico has 2 cases. Just coming from there, we haven't seen any signs of big fear. Certainly, it is probably going to expand. So I believe that this coronavirus will pass and eventually will be history. It will disrupt the supply chain right now, and we've seen not a lot of affection. So we haven't seen any of our customers canceling the rent or the pipeline being slowed. But I think, over the long term, this is like the Japanese tsunami that happened more than 10 years ago, which made all of the auto industry from Japan start to manufacture in Mexico. This is a similar event. So in the U.S.-China trade wars, with the coronavirus, will make companies to stop and rethink their supply chain. And I think manufacturing in North America for the North American market, will make more sense than sourcing from other continents. So in that scenario, we believe Mexico is going to be a winner and we're very bullish on that.

In our case, the first thing that I did -- that we did was think about our employees and make sure that everybody is safe and everybody's taking the precautionary decisions and be very aware because we don't know how far this might go. Nevertheless, talking to some of our clients, we have seen that, in most of the cases, things have been moving as usual. It's basically certain sectors that are mostly linked to China that have been somewhat disrupted, because logistics companies and shipping companies have slowed down their frights to Asia. This is mostly electronics sector as well as -- electronic sector, pharmaceutical sector, and in some cases, auto sector. Nevertheless, I completely agree with Luis. I think that in the long run, this is a yellow flag, too many companies that have established themselves too much on China to find other places to establish their operations. And they're definitely thinking Mexico, in the long run, will be a great beneficiary of many of the companies that have established that sells too much in China.

Okay. Another question here. What is the outlook on rent increases in occupancy over the next years? That will be broad. Maybe we can talk about 2020 and 2021. It's not here, but for occupancy and rent increases?

Yes. So I guess, we are in 6 markets, manufacturing markets and consumption markets. Let me talk about the consumption markets, which is mainly Mexico City, Guadalajara and Monterrey. Mexico City is the biggest industrial market. The vacancy rate in Mexico City is between 2% and 3%. There is a huge scarcity of land, and this is where you command the highest rental. And certainly, given these characteristics, that's where we see the highest rental increase in the market as there is a barrier, which is the toll booth in the north where there's just certain amount of land. So people want to -- desired to be in that corridor, but there will not be enough land. So I believe, over the long term, Mexico City will probably increase much more than inflation. I think Mexico City market rent may grow maybe 100% basis more than the U.S. inflation, so let's say, maybe 3.5%. That would be what you would expect. I think on the manufacturing markets, Tijuana is another one of the markets that will command higher rental growth. Rents are about the same as Mexico City given the land-constrained situation of Tijuana. So that is strategically -- is a market that we like. And markets that have a less rental growth will be the markets with more land, which is mainly markets like Juarez or Monterrey or even Guadalajara. You can expect maybe market rental growth, which would be, at inflation, maybe 2%, 2.5% in dollar terms or sometimes even lower than that given the supply situation. Our rollover has been 11%, our spreads on rollover. We measure that every year, and we believe that is a good spread. In terms of demand, I see demand this year healthy. It has been kept up pretty evenly in '17, '18 and '19, and we're forecasting 2020, in spite of the new administration. So demand has been holding pretty good.

Probably, I would just add to Luis that the supply from developers has been very disciplined. We see that most of the market's fundamentals have been very healthy with low vacancy rates. So I think that -- all in all, I think that it adds to having greater rent increases in many of the markets.

Another question here. If you're a private company today, what would you be doing differently? Do you want to take that?

I guess, if I -- if Terrafina was a private company, we'll be doing more development. We as being at FIBRA, we have doubled the size of the company through very accretive acquisitions. We're very happy with the fact that we bought some of the best portfolios available in Mexico. However, the developing yields are substantially better than the cap rate for acquisitions. So if we were not a FIBRA, like my friend here, white face, we will be doing much more development because of the opportunities that the industrial real estate sector presents in Mexico. As I mentioned, the fundamentals for manufacturing for export is very strong. There continues to be a lot of demand in manufacturing and that, fortunately, we do have very good industrial real estate developers that are doing very good things. And those are going to be -- those are the pipeline for us, the FIBRA, for acquisitions. But again, sometimes are a little jealous of -- by the fact that other people are doing more development with better yields and that -- developing is a lot of fun.

I'll just complement that in saying that, I think, that looks -- obviously is that the huge dislocation between the private and public markets. So I think that cost of capital most traded FIBRA's is challenged. So I think that noting, the pricing, the private sector has been in the, say, an average of 7.5 -- between 7 -- high 6s to high 7s is pretty strong compared to the private sector. So I think there's huge opportunity for acquisitions, take private, et cetera, with private cost of capital-type transactions.

And probably, in my case, if we will be private, I will probably not be delivering any dividends. I will be reinvesting all of the dividends. We know as being public, you have to pass it along to investors. But I think that being public, I think it's a great opportunity also to find some arbitrage. We have been buying back shares. And I think that's just fantastic. Whenever there's an opportunity, whenever there's a discontinuance in value, just keep buying back your own stock. And over the long run, I think, that's a way to find profitability and returns for our investors.

And just my two cents. I think the FIBRA's structure is a great structure. We just need to give it a little more time. I think over time, it is a similar structure than the REIT structure, and we've seen the REIT restructure raise a lot of capital. So I believe we just need it to give it a little more time. We had the unfortunate Mexican devaluation, and that has put it at a discount, all of the Mexican assets, in general, and FIBRA's are trading below NAV. But this is not because of the FIBRA sector. This is just kind of a Mexico issue that all of the securities are trading at discount. So I think just -- let's give it a chance. I think it's a great structure, and I would go for it. So for stabilized assets, I would keep a public vehicle. For development, I think I would have private vehicle. So that would be my two cents.

Just in time. One more here. So what do you see as the biggest risk to your tenant base over the next 12 to 24 months? And how could that result in occupancy loss?

I'll just say, I don't necessarily see security as imminent risk. But I do think that, that's something that we should all be monitoring. Security continues to deteriorate really across the country, unfortunately. It is, I guess, nearing a tipping point locally or sectors fairly insulated from security, given that, typically, you have 2 layers of security, both at the park level and then at the property itself. And it is less exposed than other sectors like retail, et cetera, but certainly a risk that we're monitoring closely. We're taking decisive action, and we'd like to see the government be a bit more proactive in taking measures to control security a bit more. So I think that's one to keep in mind.

I think the risk in our case is the U.S. economy, where we're certainly, as I mentioned, simutized with the U.S. economy, where as I mentioned, 96% of our lease contracts are U.S. dollar-denominated. And the reason for that is because of our tenants also do business related with the U.S. economy, basically exports. So the major risk in our portfolio will be the performance of the U.S. economy.

Another one here.

Yes, the fundamentals are pretty strong, exports. So what could derail exports? It's mainly some issue with the U.S., in which the USMCA gets derailed. I think we don't see that. But that's -- that could be an eventual. And I think the other driver is a very young population, which is becoming more urban, and that helps consumption. So I think those 2 drivers as long term. And in our case, we don't see a big disruption in either two. We have had a new administration, and our operating metrics continue to be pretty strong.

So is NAV a still -- still a relevant metric to value your company and your stock? And to the extent -- which extent do you believe your stock trades at a discount to NAV? What can you do to proactively close the gap to the private market NAV?

Can you repeat the first part of the question? Sorry.

If NAV is still relevant? And what's the discount to NAV? And what measures can be done to close the gap to NAV?

In our case, discount to NAV is about 20% with a fairly attractive FFO yield of 10%. What we can do is really executing on our business plan. That's what we've been doing and executing on the very profound transformation that I've mentioned, increasing asset quality, selling assets, buying back our own shares. We've bought back 5.6% already and delevering the balance sheet. So I think that continue delivering on investing our capital accretively. We've been doing that on a double-digit basis and being extremely disciplined in terms of capital management, both from the sourcing and the uses of that capital, investing for creating long-term value for our investors, focusing on the per share results as opposed to just adding value for the sake of -- sorry, adding properties for the sake of adding properties. I think very important to be very prudent in terms of capital management, both sourcing and -- uses and selling assets and buying back shares. I think it's a very powerful formula to close the gap.

I agree. In our case, we are -- we have a capital recycling program. We will, in the next 5 years, divest $600 million of assets, and we're going to be investing in the next 5 years, $600 million accretively to a; spread, to what we are considering selling. The buyback program that I just mentioned also, we will expand it to what we have acquired, which is almost 8% of the company. And thirdly, I think it's a point that Luis mentioned that this is a very young market, the public real estate in Mexico. I think we have to give it some time. I think that investors and managers are doing a good job in trying to find good communication and translating exactly what we see as value. So at some point, we believe that the value will be realized, and the gap will be closed.

Okay guys. Thank you very much.

Thank you.

Thank you.

Thank you.