Fibra UNO (FUNO11) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to Fibra Uno's Fourth Quarter 2019 Results. [Operator Instructions] With this, I'll pass the line to Mr. André El-Mann, the CEO of Fibra Uno. Please go ahead, sir.

Thank you, Michael. Thank you all for listening to our call today. I am pleased to present to you one more time, very solid quarterly results for our company. Once again, we find ourselves immersed in the financial market's turmoils of factors external to our company. This time, the potential global outbreak of the coronavirus and the apparent lack of traction of the Mexican economy in the short term, yet, once again, we have delivered extremely solid operating and financial results. The course of our company remains solid and steady. As usual, I will make some remarks on our numbers and the strategic direction of UNO. And I will ask Jorge Pigeon to go over the financial and operating figures in detail. I want to highlight that against consistent uncertainty from trade wars to the virus outbreak, we continue to surpass our own goals through diligent hard work. Just to give you some highlights, NOI per share grew 11.6% year-on-year, and the FFO per share grew 11.4% year-on-year. Total company income grew 12.8%, while total company NOI grew 12.5%. These massive double-digit growth figures are very hard to come by in an industry where 85% of our business is tied to inflation, which was close to a record low of 2.9% in pesos last year. Another group of sound statistics indicative of the health of our business, occupancy remained steady at 94.5%. GLA grew by 17.6% and have now surpassed 10 million square meter mark. In our business, size does matter. Leasing spreads and constant property performance remains solid. In peso terms, we saw positive leasing spreads of 5.7% for the retail segment and 8.6% for the Industrial segment. In dollar terms, we saw positive leasing spreads of 1%; for the industrial segment and 0.9% for the office segment. Moving on to constant property performance, we saw an increase of 2% above inflation. There is a lot of work behind the scenes in leasing, negotiating with the tenants, developing, and overall, creating value for our shareholders. Our main focus on this creation of value is resilience. The only way to endure through time, to [ pursue ] and continue to add value and create and preserve value in our properties is our main responsibility. We, Fibra Uno's management team, will embrace this responsibility and honor our commitment to bring value to our shareholders. As the steward of this company, I am very pleased with these solid results, but we do not stop here. We are not just in the business of collecting rents and deliver dividends. We are in the business of adding value to our shareholders. We strive for long-term sustainable shareholder value. In this regard, I want to highlight the acquisition of the TITAN portfolio. This is primarily a light manufacturing portfolio, comprised of 72 -- 74 properties, 1.262 million square meters of GLA leased at 95.1% and 90% of those leases in U.S. dollars. We paid $822 million for this property, which have a current NOI of $66 million, which for those who focus on the cap rates, imply an 8.1% cap rate. In addition, we also acquired a land for the future development of 1 million square meters of GLA more. Lastly, I want to highlight some benchmarks we hit during 2019 in the financial area of our business. First, I want to stress the relevance of being able to issue $1 billion in long-term bonds, 60% for 30-year bonds and 40% for 10-year bonds. This reflects the confidence of the market in our company and our business model. Additionally, we strive for innovation and creativity at Fibra. We have the first sustainability linked to revolving line of credit of any company in Latin America. And not only in the first, it is the first, it is also for an amount of MXN 23.1 billion. With these activities, we strengthened our balance even further and have now an even more solid position than a year ago. We have hiccups for this year. We expect growth all across the board, regardless of the country's number. We will continue to add new properties to our volume producing balance in the next few months. And on top of it, a very competitive level of rent allows us to fuel the expectations for yet another great year. Although we acknowledge the external and internal environment will present challenges, we are preparing the best way possible to face those challenges and endure the storm. With this, I would like to pass the mic to Jorge, so he can go over the results in detail. Jorge, please.

Thank you very much, André, and thank you everybody, for joining our call. I will now go into the quarterly MD&A. First, I would like to start with a comment on certain changes that we made to the way we present our operating information, in particular, in the business segment area of how we present the information, we separated a new category that we call Others. We took out certain properties from the retail segment. Basically, we included hotels, universities, bank branches and the hospital we have. The rationale behind this, obviously, is to present, on the retail segment, only that which is actually a retail operation. Also, we consolidated the neighborhood center category into the regional center because this is more reflective of the type of properties that we have in our balance sheet. So now we have 3 groups in the retail segment, which is faster, more regional centers and stand-alones and the Other category. Also, I wanted to add that we extracted from certain properties, for example, Samara, which is a mixed-use property where we have retail office, and industrial, we -- I'm sorry, and the hotel, we extracted that hotel from that operation and included into the other segments. So that changes the numbers a little bit, but we feel that this is more transparent. And it allows you, our investors, to better understand the company and our operations and what is that we are doing. Now diving into the numbers in -- and the MD&A for the quarter. I'll start with the P&L. On the revenue side, we increased our revenues by MXN 337 million to reach MXN 5 billion -- a little over MXN 5 billion, which puts us on the track on an annualized basis for over MXN 20 billion of income -- revenues income in the year. This sounds easy, we've become accustomed to see large numbers out of Fibra Uno, but trust me getting to MXN 20 billion in revenues has been a lot of work over the close to the last 10 years. This obviously represents an increase of 7.1% versus the income generated in the third quarter of '19, mainly attributed to the recent acquisition of the TITAN portfolio. The increases in active contracts, as André mentioned, 85% of our business is tied to increased inflation. So those contracts increase with inflation. As well as the renewals of contracts at higher rental rates, those are where the leasing spreads that were coming. Also, we increased occupied gross leasable area. And the occupancy rate of the in-service properties is starting to impact because we are starting to get into the ramp-up phase of properties, as you have seen in the past quarters have been increasing in occupancy. Now speaking specifically about occupancy, we closed the quarter at 94.5%, 20 basis points above the previous quarter. In the retail sector, we recorded a 93.3% occupancy, which is 100 basis points below that of the third quarter of '19. And the main difference for this number is the reclassification of properties, primary hotels, universities and hospitals and bank branches, which were extracted, are now included in the Others segment. So basically, retail remains stable in occupancy compared to the previous quarter. In the industrial segment, we recorded a 96.6% occupancy rate, which is 50 basis points below that of the third quarter '19. In this case, we had the inclusion of a very large new portfolio, which is the TITAN portfolio, which came in at 95.1% occupancy rate, slightly below where we had the occupancy of our industrial segment. So that dropped the occupancy a little bit, but we feel very comfortable with where we are in the industrial segment, and we feel very happy with the opportunities that lie ahead for us. In the office sector, we recorded a very solid 83.6% occupancy. And in the Others category, it's 99.7% occupancy. Basically, as I mentioned, it includes hotels, bank branches, universities and the university campus and one hospital. So these are long-term contracts, there should be very little movement with the except of probably the bank branches. This should be a very stable segment. The In Service properties decreased from 81% to 72%. You should not view this as a loss of tenants in the In Service property, rather, what we did is include Torre M which is a brand-new office tower at Mitikah, which is in its ramp-up phase, has an occupancy of close to 50%. And obviously, this brought down the average for the in-service segment. But we are very happy with the lease-up process that we are having in Torre M. As a matter of fact, I think if we were to report today, the occupancy of Torre M would be significantly higher than that 50%, or close to 50% I just mentioned. So we're very pleased with the performance of Torre M, in particular, and the performance of our In Service portfolio. Moving to maintenance expenses, property taxes and insurance, we had an increase of 21.8% (sic) [ MXN 21.8 million], 4.6% from the previous quarter, mainly due to expense seasonality. We had an increase in insurance expense of MXN 1.1 million, basically, as a result of adding properties recently acquired as well as properties that started operations. For example, Torre M at Mitikah would be one of those examples. Taxes increased 95 -- MXN 9.5 million, 6.7%, mainly due to the acquisitions of the TITAN portfolio and updated square meters properties that were under development and are now operating. Now moving to net operating income. We had an increase of MXN 250 million almost, 6.6% compared to the previous quarter. This puts us above the MXN 4 billion mark, again, on track to be over MXN 16 billion in net operating income if I annualize this figure. Again, as I mentioned before, so we've gotten used to large numbers at Fibra Uno, but having a net operating income of MXN 16 billion is no small feat. So we are very pleased with the fact that we are able to reach this new milestone. NOI margin calculated over property revenues stood at 88.1%, 79% if we look at total revenues. If you recall, the commitment of Fibra Uno when we IPO the business, was to have the NOI margin over rents above 85%. And I think we've significantly beat that commitment quarter-over-quarter since the company came public. In terms of interest expense, we saw a decrease of 2.8%. I'll spend a little bit of time on this one to explain what's happening and why we saw a reduction in interest expense even if we increase the amount of debt that the company holds. Basically, I will go to the point #3 of our MD&A, which is the effect of capitalized interest linked to development and acquisitions. The development, as you know, we've discussed before, properties under development, our financial debt and the interest associated with that investment as part of the cost of the investments that is capitalized. However, in the fact -- in the acquisition of TITAN, if you recall, we issued bonds in June of last year, the 10s and 30s that André mentioned earlier in his introduction, and this became part of the moneys that we used for the TITAN acquisition. We paid interest on those bonds from June to the time we closed TITAN somewhere in November of last year and the interest we paid associated with that acquisition is part of the acquisition cost of TITAN. Therefore, we have to capitalize that interest. This is a one-off. This is something that you will not see repeated again in future quarters. Secondly, I will also mention that the amount of capitalized interest that we are having as an ongoing basis, given that we are approaching the tail end of a lot of the development pipeline that we currently have is decreasing to the extent that we do not add more development. We could expect to see a decrease in capitalized interest expense. Another matter that also induced a slight reduction in the interest expense was the FX change that we had. The peso appreciated during the quarter. So that also results in less interest expense. If you recall, about half of our debt is in U.S. dollars. So that reduced slightly the amount of U.S. dollars that we have. So I wanted to spend a little bit of time explaining that, just so that everybody was clear on why, despite the fact that we increased the amount of [ debt ] we ended up with slightly less interest expense. Also moving on and including some of this capitalization of interest, I'd like to make a comment regarding the fourth quarter of 2018. If you recall, during 2018, we started to capitalize more interest associated with the development properties than we have previously been doing, and the fourth quarter was a catch-up quarter in which we recorded more interest capital -- more capitalized interest than we should have, proportionately, if we had done it linearly throughout the year. So if we normalize the fourth quarter of '18 for the amount of capitalized interest that you should have received, instead of having the catch-up, the growth of FFO would have been 14.8%. I just wanted to make this highlight because it appears that there's a discrepancy and the discrepancy just has to do with this capitalization of interest. Now moving on to funds from operations. Majority funds from operations or FFO controlled by Funo increased by MXN 254 million, 11.5% from the third quarter of '19 to MXN 2.475 million. Adjusted FFO increased 10.9%. And if I look at FFO and AFFO per CBFI, both stood at MXN 0.6302, which, obviously, we're very happy to have broken the MXN 0.60 mark significantly with this MXN 0.63. Also, I would like to highlight that as one of the commitments we had in Fibra Uno was that we expected the payout throughout the year to be below AFFO. Obviously, we had some quarters in which we pay more distributions than the FFO generated in that quarter but we knew where the company was headed and expected to be able to have a payout ratio below that of FFO, and we are at 99.3%, I believe, in our AFFO payout. So we're again on track, clearly, with our commitments. Now moving on to the balance sheet. Accounts receivable had a decrease of MXN 160 million -- almost MXN 161 million, it's almost 10% decrease in accounts payable, which we're very pleased to see. Obviously, it's, as André mentioned, there is a lot of hard work behind the scenes going on at UNO. So we're very happy with the performance of the accounts receivable. In terms of investment properties, this is a line in which we saw a lot of movement, an increase of MXN 23.6 billion almost, including basically the TITAN acquisition. This is the one that has the highest impact. The acquisition of Tepeji which is, if you recall in our Investor Day, we mentioned that we had a batch one and batch two of properties. This is the first acquisition of that batch one of properties, which we have denominated Hercules. So if you now see Hercules as opposed to batch one, we're talking about the same thing. And this is the first property from that acquisition. Obviously, we continue to invest in development, and there is the effect of asset valuation. We do a mark-to-market of our assets, 100% of our assets every year. As you know, we have our own internal checkup process to validate what third-party appraisers are doing, but this is a quarter in which we get the third-party appraisal for all of our properties, and this is included there. I would also like to highlight one minor change in how we account for our properties, and it is that we are now valuing Mitikah not at cost but at its appraised value. And this is a requirement by the bylaws or the trust contract which includes the requirement to have a third-party valuator. And the valuator decides when it is time to start valuing the property at what he considers fair value. This is the quarter in which this happened. So just to highlight for yourself, Mitikah is no longer carried just at cost, it is going to be a fair value appraisal by the appraisers that have been hired by the CKD Helios to carry out the appraisal. In terms of debt, as I mentioned, we went from MXN 98 billion to MXN 107 billion. And the main increase in the debt is the loan we acquired for the TITAN acquisition of $500 million. And there's obviously other loans associated with construction and normal working capital management of the company, including primarily investments in development. Also included here is the effect of the peso appreciation, which obviously gives a lower value in terms of pesos to the U.S. denominated dollar debt that we have. So all in all, the net effect on our equity is that we increased almost MXN 5 billion, our equity base 3% compared to the fourth quarter of '19. This includes the derivative valuation, which has the impact of the FX that I mentioned. Net income generated by the quarterly results, the distribution and also the deployment of the Executive Compensation Plan, which also adds a little bit to our equity base. Now I'd like to highlight some of the operating results, specifically the leasing spreads. We are very, very, very pleased to see that in peso terms, our retail segment recorded 570 basis points positive leasing spread. This means 5.7% above inflation. It's a very, very solid figure. In Industrial, we were 8.6% or 860 basis points. We had a negative 130 in the office segment. But this is obviously a segment that is primarily leased in dollars in most of our buildings and it doesn't represent a big chunk of what we're doing. Now as I move to the dollar contracts, the two most important ones are industrial and office. In the industrial segment, we had 100 basis points or 1% above inflation, which is 50% of U.S. inflation basically. And 90 basis points, almost 50% above U.S. inflation for the office segment. So we're very pleased to be able to deliver almost 1% above inflation leasing spread in U.S. dollars for both industrial and the office segment. We recorded a negative 200 basis points in the Retail segment, which we do not think is significant at all. Basically, we had some tenants moving out of La Isla 1 into La Isla 2 and that generated a negative leasing spread in the retail segment. That's the area where, as you know, we generate most dollars. In retail, it's a very small portion of our income generated by the retail segment. So it's really not material, but just part of the report. In terms of constant properties, as André mentioned, very pleased to have 200 basis points above the annual inflation. So it's a very, very solid figure to be able to show that on a constant property basis, which is when you mix everything you're doing into a group of constant properties. If you're adding space, reducing space or whatever, we are able to increase 200 basis points. So we are very pleased with that performance. And lastly, at the subsegment level, you will see -- I just wanted to make one highlight regarding this. You will see that the average rent of the company went from MXN 180 to MXN 164. And this is very easily explained by the acquisition of TITAN, which is basically 1.3 million square meters that were added to our portfolio. And as you know, industrial has the lower rent per square meter of the 3 segments, at an average of 4.6. That's exactly the average for the TITAN acquisition. We had a slightly higher average in the light manufacturing industrial so that is why you see the drop in rent. It is not because we are decreasing rents. It just is the effect of this new acquisition, which came with, what I would consider close to market rents for the light manufacturing, industrial segment. Now with this, I conclude my presentation of the numbers. Michael, I would like to hand over the call back to you, if you can open, please, the floor to Q&A?

[Operator Instructions] So we have the first question from Miss Vanessa Quiroga from Crédit Suisse.

This is Vanessa. My question is regarding the Hercules portfolio. So if it is the batch one that you announced at the Fibra Uno Day, then just to confirm, there are still 390,000 kilometers -- sorry, 390,000 square meters still pending to acquire? Can you confirm that number? And when -- what's the time line when you expect to complete the acquisition of the whole portfolio? And also who are the sellers in this Hercules portfolio? And specific for the property that you acquired in December located in Tepeji, if you can provide any details on where the tenants, more or less that term of the contracts in terms of currency and duration? And if you expect to -- if Fibra Uno will pay an acquisition fee for this transaction?

Vanessa, thank you for your questions. Actually, Hercules, I expect that we will be closing it. Ideally will be about by the end of this quarter. It's a challenge, but definitely, you can count that it will be closed by the end of second quarter. And the total area of the portfolio around 490,000 if you deduct the case of Tepeji and the Lagos Tres. Definitely, that's what will be transferred. As of today, I don't see any issue, transferring the rest of the portfolio. And what was the second part of the...

The seller and [indiscernible]

Actually -- the seller -- it's -- this is a mix of sellers. It's not a single seller. In each one of the properties, you find out a different mix of owners. In all cases, there's a part or a portion that is from related parties. And the fee that will be charged will be only for the non-related parties portion.

Okay, Gonzalo. So just a detail to understand Hercules portfolio, so in this total square meters that you mentioned 490,000, it includes Lagos Tres? And what is the area of Lagos Tres?

Actually, Lagos Tres is just the second portion of Lagos Tres, and it's around 95,000 square meters.

So 95,000 of Lagos Tres is what is included in Hercules?

Yes.

Okay. Excellent. Thank you. And can you provide dividend guidance for 2020? Do you have guidance on dividends?

No.

It's something that, as you know, Vanessa, we, as a company, have a 3-year guidance policy because there's a lot of moving pieces that don't necessarily fall under our control, like -- for example, the Mexico City government stopping all construction in the city last year and things like that do happen in this industry. We feel very confident on the 3-year guidance, it's something that we can get to and we can deliver. On a 1-year guidance, we don't feel comfortable, so we don't provide guidance.

Our question comes from Mr. André Mazini from Citigroup.

Yes, sure. So my question is on batch two now. I remember that batch two is supposed to be very Mexico City centric, right? And logistics centric as well. So if you can provide maybe timing on batch two? If you can extrapolate so -- you just said that batch one is a mix of related parties and third parties. Is that's also the case for batch two? And as you are going to be having an interesting logistics portfolio now, not so much the light manufacturing one, and coupled with the fact that, of course, UNO is the biggest real estate player in Mexico, what initiatives do you think you guys can do in terms of omni-channel? Because normally, we think of omni-channel being a lot on the tenant side, right? Their operations, they are wanting to either return products in different locations, et cetera. But is there anything that the landlord can do to help tenants to do omni-channel? So last mile delivery or returning through the retail portfolio, things of that nature?

Let me answer the first part of your question, and the second one, Jorge will take over. In terms of the second batch, as I have mentioned on the Investor Day, it's mainly logistics with a large concentration in the Mexico City metropolitan area. Even there's also some logistics in the Cayetano area. And as the Hercules portfolio, a big one, it's a mix of sellers. It's not a portfolio as probably TITAN was. This is the mix of sellers and will be exactly the same case that we have some related parties in both in almost all properties, even there are probably one or two that they are not involved in the portfolio.

Just to add to Gonzalo's comment, that's why we did not call it a portfolio but a batch, because it's not properly a portfolio that is controlled by one group. So it's a group of properties, and that's why we've called it a batch. Now in terms of e-commerce and omni-channel and things of that nature, one of the key philosophies of Fibra Uno is always to work with our tenants. The reason that we grow, and we have grown so much is because we grow with our tenants. If our tenants are growing their operations double digits on the retail side, and we are providing for them on the logistics side, that means that eventually, they're going to require more space on the logistics side, and we need to be able to provide for that. One of our key areas of expertise, specifically, I would say, one of the areas that the founders of Fibra Uno probably start strongest with was the logistics operation. So we know the concepts and the inner works of logistics very, very well as a company. One thing that is tricky about the last mile and why it is becoming complex and expensive for a lot of people to do is because in order to deliver that last mile, you need to have space that is close to the end user. And if you want to go and buy today a 100,000 square meter space to do a distribution facility for e-commerce in the heart of Mexico City or in the middle of Colombia [ indiscernible ], if you know, Mexico City or in the middle of Polanco, that simply is not available. It does not exist. You'd have to probably buy a bunch of houses. It will be extremely, extremely, extremely expensive. Now what we do have is our shopping malls and the shopping malls have something which is already equipped into the shopping mall, you don't see it because it's built in a way so that you, as a user of the shopping mall, don't see it but we have the docking facilities for trailers to come in and unload merchandise into the shopping mall. So we already have the logistics operation built inside our shopping malls. So for us to transform a portion of our shopping mall into delivery centers where you could get the last mile delivery coming out of that location. For our retail customers is something that we could very easily very easily do so I think that we already have the solution to do that in our hands because we own the land, and that's why we have said since day one that this sounds cliché, but it's not. Location, location, location is the #1 variable in the real estate game. And if you have a very well-located shopping mall, you're going to be close to those end users that are going to be end up buying through e-commerce. And the tenants, which are requiring the e-commerce, already are our tenants. We already have the facilities to which they can distribute. So it's just a matter of working with what we already have in place. The most important thing of it is the location. Having said that, obviously -- and this is something that we have obviously stated before, we have seen e-commerce penetrate, but not as thoroughly. Now I think that André would like to make an additional comment.

Thank you, Jorge. All in all, all the portfolios from TITAN to batch one and batch two or whatever you may call them, our decision that we made long ago, to get to this point where we finally set up first, TITAN, and we closed on the deal on TITAN, and then batch one and batch two, which we are very close to, to finish and finalize the transactions of both groups of properties. Our decision that we made a while ago. The decision -- the main decision was we want to be diversified. We were exceeding in the retail world. Our desires. Our desire from day one was to be around a universe of 40%, 40% and 20%. 40% industrial, 40% retail, and 20%. As the opportunities come, we need to close on them, and we closed on the opportunities happen to be that the opportunities came along on retail, retail retail, retail, and we wanted to level, we wanted to balance our holdings. Please note that today -- because today, the market is hot on industrial, we turn our heads to industrial. It's a philosophy that we have since day one. And now after closing on batch one and batch two, we would be close to 11 million square meters. And this is what's important for me. 11 million square meters is 11 million of responsibility for the management team. And we agree on that. We will take that responsibility, and we will act responsible and we will act with all the knowledge that we have on the matter to manage those properties and make them profitable for our shareholders. But it's more than the bad and who the seller and what the seller and last mile and the logistics, et cetera, et cetera, et cetera. It's not that much of -- you don't need to give that much of a talk. You need to understand that we have a very clear model, and we will follow the model. And now it's staying. Now the model is there. Now we have the property of the industrial. We are the largest by far in the country, and we will feel very comfortable because now our position in the industrial world gives us strange -- strength at phasing our tenants of the retail world and our tenants of the office world and, of course, the tenants of the logistics world. So we feel very comfortable with what has been happening and going on with our portfolio. But it's more of looking at it of a higher altitude. It's a philosophical matter.

We will now move to the next question from Mr. Froylan Mendez from JP Morgan.

I saw that the acquisition pipeline increased very much during the quarter, likely explained by these Hercules new pipeline, but could you explain to us from the Others portion of that acquisition pipeline that is around MXN 5.6 billion, what's included there? And what could be the timing on those acquisitions in the Others?

Yes. Yes, there Froylan. Actually, it's mainly a sale and leaseback that we are cooking, which is for a different set of withstanding assets that will be a stand-alone, we will be considering them as stand-alone like the bank branches of Santander. And it's a long-term lease that we're dealing with, and that's mainly it. As this is as far as I can go at this stage.