Primaris Real Estate Investment Trust (PMZUN) Earnings Call Transcript & Summary

Good morning, and welcome to Primaris REIT First Quarter 2022 Financial Results Conference Call. [Operator Instructions] During this call, management of Primaris REIT may make statements containing forward-looking information within the meaning of applicable securities legislation. Forward-looking information is based on a number of assumptions and is subject to a number of risks and uncertainties, many of which are beyond Primaris' REIT's control, that could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additional information about these assumptions and risks and uncertainties is contained in Primaris REIT filings with security regulators. These filings are also available on Primaris REIT's website at www.primarisreit.com. Your host for today's call will be Mr. Alex Avery, Chief Executive Officer of Primaris REIT. Mr. Avery, please go ahead.

Thank you, operator, and good morning, everyone. Thanks for joining us today to discuss Primaris REIT's quarterly results. Joining me on the call, Patrick Sullivan, President Chief Operating Officer; Rags Davloor, Chief Financial Officer; and Leslie Buist, Senior Vice President of Finance. The team and I have of lots of interesting updates to share. Q1 results are strong and reflect the business running ahead of our prior expectations. Pat and Rags will provide further details on our recent performance and our prospects over the remainder of 2022 in a moment, but I'll share a few thoughts about how our team and business are progressing. Two weeks ago, we completed our first company-wide asset management conference since becoming a stand-alone company, bringing together general managers and property managers from across the country with our asset management team to review and assess business plans for each of our assets. This was the first asset management conference that I've participated in since joining Primaris, and I was struck by how passionate our team is about our properties. There is a clear positive momentum in our business at the property level with committed occupancy rising, rental rates growing and significant room for further growth. As we explore the opportunities embedded within our portfolio, it was clear that by transitioning from a subsidiary of a larger company where we represented 20% of the asset base to becoming a stand-alone company where our business represents 100% of management's focus. We now have 5x the attention being paid to each asset. And that means 5x the focus on opportunities embedded in our portfolio as we see the cyclical recovery unfolding over the next few years. This is reflected in our raised guidance detailed in Section 15 of our MD&A. We continue to make progress, significant progress finding our stride organizationally with these our second set of financial statements now reported. Our asset management conference under our belt. We're building out our financial reporting team and our financial planning and analysis team and working on continuing to expand and refine our disclosure package in keeping with investor demand and best practices. We continue to see very attractive opportunities to deploy capital and leverage our management platform. These opportunities span acquisitions of leading shopping centers from Canadian institutions and intensification and redevelopments of our existing shopping centers to buying back our units for cancellations and deploying capital to lease up space in our owned portfolio. Pretty much everywhere we look, there are significant opportunities that we can act on to create value for our unitholders. I'll now turn the call over to Pat to discuss our platform operating and leasing results, followed by Rags who will discuss our balance sheet, financial results and provide you with an update on our disclosure package. Pat?

Thank you, Alex, and good morning. Our teams have diligently integrated the HOOPP properties, reviewing and identifying opportunities to increase value in these new centers. We've been applying our management technique to decentralize services by empowering our general managers to actively manage these properties. Specifically, we target lowering costs to align with the core focus of Primaris, providing affordable space for our retail partners, increasing occupancy by leveraging our relationship with retailers and the identification of development opportunities on excess land. During the first quarter, sales averaged 91% as compared to the same period in 2019, while January sales lagged to 78% of 2019 sales due to the uprising of the Omicron variant. Portfolio-wide sales increased to 97% of pre-pandemic levels in both February and March. Food courts, typically a barometer for mall traffic continue to show rising sales activity with the February and March sales being at 80% compared to pre-pandemic figures. Q4 2021 portfolio food court sales by way of example was 75%. Leasing activity continues to be strong, continuing the trend from Q4 2021. Several large renewal transactions were completed during the quarter, specifically Sport Chek at Place d'Orleans, where they occupy 68,500 square feet and Cineplex at Devonshire Mall, where they occupy 58,000 square feet. In addition, we completed a transaction with Sephora to open a new store at Place du Royaume, a highly productive international tenant owned by LVMH. With new Sephora stores opening a Stone Road Mall in Guelph and McAllister Place in St. John later this year. Primaris has grown its partnership with Sephora to 11 locations with several more locations currently under discussion. Overall, renewal rents were up 2.5%. CRU renewal rents were modestly lower by 3.7%, while large-format renewal rents grew by 15.4%. If we exclude 4 CRU tenants totaling 7.5% of the total square footage renewed during quarter that were renewed at lower rents and on a short-term basis, CRU renewal rents would have increased by 1.5%. With sales increasing and positive absorption, we expect metrics to continue to improve. In-place occupancy for the combined portfolio was 85.9% at the end of 2022, with the original Primaris portfolio at 87.2%, and the fixed acquisition properties at 83.5%. The original Primaris occupancy figure is relatively flat to Q4 2021 and Q1 2021, and include the Northland Village Shopping Center, which is in the process of being converted to an open air center. If we exclude Northland Village from the in-place occupancy statistics, the original Primaris occupancy would have been 89.9% as of Q1 2021 compared to 88% in Q1 of 2021. And committed occupancy would have been 92.2% as compared to 90.6% in Q1 of 2021. Primaris properties are located more than 900 acres of land, typically located on main commercial thoroughfare and proximate to public transit, and we continue to review options with regard to excess density. We have reviewed -- we have received conditional approval at Dufferin Mall in Toronto to construct approximately 1,200 residential units as part of the redevelopment of a 4-acre primarily used for parking at the north end of the property. Approval is conditional on working through administrative process with the City of Toronto, and we anticipate unconditional approval by the end of June 2022. We are considering options to develop or monetize all or a portion of this land. Northland Village in Calgary is scheduled for redevelopment with plans to demolish the interior mall this spring and convert the property into a mixed-use open-air retail center. Approximately 2 acres of land was recently severed and sold to a residential developer for $5.8 million. The developer has commenced construction of 240 residential units, which are anticipated to be ready for occupancy in Q1 of 2023. Redevelopment plans for the shopping center are conditioned on pre-leasing efforts and we expect the development to be constructed in phases over a 3-year period. Additionally, we have commenced construction on several other development projects being the redevelopment of the former Sears store at Quinte Mall in Belleville, 30,000 square feet of this space has been leased to winners, and they are expecting to open in Q1 2023. The remaining 60,000 square feet is being demolished in favor of construction out -- constructing outparcel retail on the periphery of the property. Pre-leasing efforts are underway. At Cataraqui Mall in Kingston, we have commenced construction on the redevelopment of the Sears store, which will incorporate our first to market 15,000 square foot L.L.Bean store. At Medicine Hat construction commenced for a new 35,000 square foot FreshCo store with an anticipated opening date of Q2 2023. Lastly, we are completing the redevelopment of the former Sears at Lansdowne Mall in Peterborough, Sport Chek is relocating and expanding into 24,000 square feet and is expected to open in December of 2022. We are in discussions with several large format retailers to lease the remaining 20,000 square feet of space and anticipate announcing a transaction shortly. And with that, I'll turn the call over to Rags to discuss our financing and financial results.

Thanks, Pat, and good morning, everyone. Our financing strategy built upon our differentiated low leverage balance sheet that's based on the approach of disconnecting the right side of the balance sheet from the left through the use of unsecured debt. This allows us to actively manage our property portfolio, while providing maximum flexibility to produce a well-laddered debt maturity profile and optimize our cost of capital. This strategy, combined with our scale, enabled the achievement of an investment-grade credit rating of BBB with a stable trend by DBRS Morningstar in early March. Shortly thereafter, Primaris successfully issued its inaugural investment-grade debenture offering, which has met the strong demand -- strong and broad demand from institutional investors. We issued $250 million aggregate principal amount of senior unsecured debt in 2 tranches with a combined weighted average interest rate of 4.46% and a weighted average term to maturity of 3.9 years. By locking in these rates, we've reduced our interest rate risk in a rising environment, while the 2 tranche structure enables our debt but enhances our debt maturity profile. In addition, at March 31, we had no floating rate debt and the proceeds from the bond issuance was used to pay down our operating loans. We have a state of secured debt as a percentage of total debt target of 40%. As at Q1, this ratio stands at 62.2% with a solid investment-grade credit rating in place and our first unsecured issuance now in the box, we plan to further advance our unsecured financing strategy, lowering our secured debt ratio to target as a testing mortgages payable mature. In the near term, we plan to use our operating facilities to retire our upcoming debt maturities. At present, our most attractive use of capital is buying back units at a deep discount to net asset value per unit on a leverage-neutral basis. Our NCIB is in place and we are buying back and canceling units daily. As of today, we have bought and canceled approximately 600,000 units for $9.4 million at an average price of $14.80 per unit. As Alex has already mentioned, we're building out our financial reporting, planning and analysis team and working on continuing to expand and refine our disclosure package to create useful and insightful financial and operational information to help you understand and evaluate our business. New disclosure additions for the quarter include details around our redevelopment and development projects, leasing activity, including rent and spreads, more details around our debt maturity schedule and the easier ability to measure us against our stated balance sheet targets. We have updated our forecast for the current year based on our Q1 results and our outlook for the balance of the year and a $2.7 million impact on interest expense as of January -- as a result of the January 4 conversion of the exchangeable units. Overall, we have increased our forecasted net income by $4.1 million. We also added new metrics, including FFO, AFFO and their respective payout ratios, same-property NOI, debt to adjusted EBITDA and the composition of FFO and AFFO on a per unit basis, among others. In order to give additional clarity and information on the total portfolio results, we have produced a supplemental where we benchmark Q1 actual results versus the 2021 pro forma for the combined property portfolio. If you have not already done so, we encourage you to review this document in addition to our report to unitholders. Now to our financial results. Same property net operating income was up 8.2% in the quarter, reflective of post-pandemic recovery and improving tenant sales. In our 2022 forecast, we've increased net operating income by $5.1 million or 2.7%. Interest expense was larger in the quarter versus forecast. As we extend one of our loans -- as we're extending one of our loans by 6 months at a rate of 2.6% and as previously mentioned, the positive impact of the exchangeable unit conversion. The creation of Primaris as a stand-alone entity necessitated the addition of startup costs, including hiring key team members and other public company costs. Also, salaries and benefits costs for certain positions were historically paid by a former parent and are now cost of the REIT. G&A for the quarter was $5.7 million. Consistent with the financial forecast published in the MD&A, we expect this number to grow as we onboard key members. In the forecast, we increased our G&A by $2.8 million, primarily to reflect unit-based compensation that was not previously budgeted. FFO and AFFO per unit was $0.38 and $0.30 per unit, respectively. As I mentioned earlier, we've included a table in the disclosures that enabled you to quickly understand the composition of FFO and AFFO from both the total and per unit basis. Primaris FFO and AFFO payout ratios were 52.5% and 66.1%, respectively, slightly above our FFO payout target ratio of 45% to 50%. We expect this payout ratio to normalize as we move through 2022 and 2023 and capitalize on the occupancy improvement opportunity in the portfolio. Primaris fair value of investment properties was essentially flat during the quarter with an extended valuation the 3 properties with fair values totaling $517 million or 16.1% of the portfolio. The small adjustment was due to CapEx incurred in the quarter that was written off. We are conservative fair value modeling and we'll reevaluate our valuations in the following quarters. Assuming continued improvement in NOI, we're expecting the values to increase. Obviously, any impact on the current economic environment on cap rates may also have an impact. Based on the price value of our assets, we ended the quarter with a NAV of $22.05 per unit and debt to total assets of 28.4%. And as we've scale and highly differentiated financial model acknowledges both the clear public -- clear preference public investors had a full reach of conservative financial models and the advantages of having the lowest leverage amount of Canadian REIT providers. We are committed to our differentiated financial model, enabling Primaris, the soft funds its grown. In conclusion, we have a wide breadth of attractive investment opportunities. Our excess retained cash flows allows for internally funded growth and reduces our reliance on external capital sources. We believe this capital that this structure should support reasonable cost and access to capital. As we move through the year, we will continue to build out our financial and operating disclosure and welcome your feedback. We endeavor to provide you with information you require to assess our value our business and its progress. And with that, I'll turn it back to Alex.

Thank you, Rags. In a complicated public markets environment, we are focused on delivering on our stated business plan as we have detailed publicly. We anticipate that over the next several months, we will have a number of opportunities to enhance investor confidence, including: continuing to build out comprehensive reporting and disclosure package; reporting successive quarters of financial and operating performance; supporting broader research coverage and investor awareness; demonstrating disciplined capital allocation and capital recycling as well as further unit repurchases; building out and communicating our ESG strategy; supporting our retail partners as they optimize omnichannel business models; and benefiting from further normalization of consumer behavior. We believe there is a great to deliver compelling investment returns to investors and look forward to delivering on that potential. We'd now be pleased to answer any questions from the call participants. Operator, can you please open the line for questions?

[Operator Instructions] We have our first question from Sam Damiani of TD Securities.

Congratulations on your first quarter for Primaris REIT. Just on the raised NOI guidance, I guess, could you point to see specifically what new information during the quarter led you to make that decision? Just looking at occupancy is fairly flat. Just wondering what drove the push to raise the guidance?

Well, Sam, I noted that we had just recently completed our first asset management conference following the spin-off. And included in that process is a reforecast and an update of the budgeting at each of the properties. And I can't really point to one specific thing, but I would say that in general, we've just had a better-than-expected experience in terms of the lease negotiations and recoveries and just a refining of forecasts. So it's a whole bunch of little things. But with that, I think if you were looking for some examples, better percentage rent in low performance, slightly better outcomes from lease negotiations, better recovery of costs. Pat, anything else?

I think in general that we went through the pandemic, it was a dynamic -- we had quite a dynamic impact, especially on a closed mall. When our forecast for first time we're in a much more -- we're in a bit of a different environment and acted with a more conservative approach as we came out of the pandemic. And now the restrictions are completely lifted, we're realizing much stronger sales and we're more optimistic about where sales are going and where the rental growth is going to go.

Yes. I think one of the big areas, Sam, is just on the bad debt expense, we've sort of dialed that back because we were fairly conservative given the environment. And a lot of the tenants, the failures have been flushed through the system in the last 2 years. So we're not seeing sort of that type of stress and taken on significant bad debt provision. So that has definitely helped the numbers.

Yes, I guess, just to add one further thing. The prior forecast was the forecast that was prepared in the late summer, early fall last year and last quarter with Q4 results, while we did changed the presentation. We didn't change the substance of the forecast. So this was the first comprehensive review of our forecast since then.

Yes, that's a good point, Alex. I appreciate it. Certainly, the outlook has brightened over the last sort of 9 months. Maybe just moving on to occupancy and we've seen the GLA for the portfolio be revised lower by about 230,000 square feet. So some demolitions are done or planned here, specifically in Ontario and Alberta. Is that Quinte and Northland Village that we're seeing reflected in this stats this quarter?

Yes.

Okay. And is there any other sort of revisions planned in the earnings term as we look to the balance of the year?

As we move through a couple of the other Sears development, specifically Devonshire, where we have a 200,000 square foot Sears box, I think the plan right now is we'll eventually look to demolish that and redevelop that into the shopping center. So that's the most notable one. Other than that, nothing of any great significance.

Okay. And I guess when we just want to look at the in-place occupancy, it was down only 10 basis points on the quarter. But when you factor in the reduced GLA, the occupied GLA is actually down by over 200,000 square feet. So is there any context this year there as to why that transpired in the first quarter?

I think as we move from Q4 to Q1, we naturally see a dip in the occupancy just because of the seasonality of our business. And then I think as we move to the MTO Northland Village, that had an impact as well. I think it's just really -- it's driven by the seasonality for the most part.

Okay. Last one for me, and then I'll turn it back, is just, Rags, you mentioned using the credit facilities to deal with some near-term mortgage maturities. Is that a reflection of the market pricing you're seeing for insecure right now? Or is that just sort of building up some size before you come to market for with another offering?

Yes, it's -- we want to get the unsecured ratio below 40 -- sorry, the secured average to below 40%, which through a couple of these refis pay a ticket up to the off-line will get us there. And then we just sort of want to build up that bucket a bit before we flip it into an unsecured take out. Just to your point, there's a considerable difference in spreads between secured and unsecured. So we are monitoring that and trying to figure out how that -- what the right mix is. But first thing we want to get -- do hit our targets, get everything lined up, and then we'll start to play with the mix of secured versus unsecured.

The next question comes from Sumayya Syed from CIBC.

Just to follow up on the increase in your NOI guidance. I'm noting your comments about the recovery happening on in-place rent. Is your guidance incorporating any gains on the occupancy side as well? Is that going to stay more stable? Just wondering about your impact of occupancy and your guidance there?

The guidance reflects a end of year occupied guidance of 87.3%, which is slightly lower than the committed occupancy, and that's on a portfolio-wide perspective. But as you can imagine that the committed space that's going to take occupancy between now and the end of the year is spread relatively evenly throughout the year. So the NOI guidance increase isn't really primarily driven by an occupancy improvement. It's some of the reforecasting, some of the percentage rent in lieu and other contributions.

There's no such thing as sales improve, we're getting a lift. And so you don't necessarily have to see big occupancy gains as the sales start to rebound and we are geared a little bit more today to percentage rent because of some of the percentage rent and new deals. So that's having an impact.

Okay. And then just looking at the leasing spreads in the quarter and basically the 15% lease for the large-format tenants. Do you think that's a number you could sort of repeat with the other large formats? Or also was it something specific to the 4 tenants that renewed in the quarter?

Yes, it's going to always be dependent on which tenants are expiring if they have fixed rate renewals or whether they don't have fixed rate renewals and what they might be at -- what those rates might be at. In this case, we had tenants with fixed-rate renewals that drove the number, and they were coming off low basis. In the future, we're going to -- with the majority of our former large-format anchors are being Sears in target. We have a lot of our major are smaller, and they have step-ups in their rent built into the renewal option. So I think we're going to continue to see a good spread on the large format, whereas historically, we really didn't see any lift due to the nature of the anchor leases that were in place.

Okay. And just lastly from me from your commentary and given the increased confidence and the visibility in the business. What can we expect from a fair value update going forward?

So we do have sort of a new forecast numbers. We want to just get through Q2, get -- make sure we have the strong confidence in those numbers. And then through that process, we look at the valuation. So there is potential as the NOI grows to see some positive impact. Obviously, the big unknown right now is where discount rates and cap rates are going. So we'll hopefully have some clarity around that over the next 3 months. But simply, on the NOI front, we're set out to see positive increases.

[Operator Instructions] We now have next question from Mike [indiscernible].

Congrats on the strong quarter. A few housekeeping questions on my end. What's the property under redevelopment that you disclosed separately in the NOI reconciliation? I just want to confirm that solely relates to Northland Village?

That's correct, yes.

Okay. And would that reflect the entire property? Would be question one. And number two, are you capitalizing the operating costs on the interior mall yet?

Yes, the answer is yes to both.

Answer is yes to both. Okay. Great. On the leasing disclosure thanks very much for the incremental color there. With the percentage of gross leases in the portfolio or with the gross leases that you have in the portfolio and splitting that out, do you have a sense of what the -- how much of your portfolio would be covered by gross leases as opposed to that?

In terms of percentage and other than gross leases? It's in and around 10%.

10% of your portfolio would be gross leases, not net leases?

Gross. Yes, percentage rent lease, the percentage rent gross leases. Yes, other than that.

Okay. Great. Do you happen to know what the average contractual rent step would be in your portfolio?

No. Not at this point. we will look to enhance that disclosure. But at this point, we don't have those numbers in hand.

Okay. Sorry, go ahead.

I was just going to say the preferred form of lease that we've been using for the last few years as a 2% annual escalator. But we're just in the process of trying to track down exactly what share of all leases have that built in at this point, but we've been transitioning to that format.

Okay. And then just maybe following up on that comment, Alex, I know things are improving. There still is a recovery element to it. But with the inflation that we're seeing generally across the world, I guess. Has there been any effort to try and push that number higher? Or is it still too early to look at that, just given where the fundamentals are for the business?

Well, from a business perspective, I think it's worth noting that 14% of our portfolio is vacant right now. So we have effectively 14% of the portfolio at market, and we have the opportunity to capture that as we lease the majority of that space back up. I think as we get our occupancy higher, we get better negotiating tension with the tenants. And as was noted in the disclosure around this quarter's lease renewals, depending on the nature of the tenant, you've had some pandemic boom type of retailers that were doing extremely well over the last couple of years, and you've had on the flip side of that tenants that have suffered through the pandemic. And so it's really quite a dynamic situation have had in line with the -- were a few leases where the tenants were pushing for lower rents and wanted term commitments. And as a compromise, we wanted to keep them in the portfolio, have a high degree of confidence that their sales either have already begun to recover or are in the process of recovering. And our solution for that has been to do short-term extensions because we believe that we'll have a better ability to capture higher rents a year from now, 2 years from now. So with a weighted average remaining lease term of 5 years and 14% of the portfolio on occupied right now, we've got, I think, a pretty strong position to be able to capture inflation over the next few years.

No, that's good. That's a good point. Okay. Congrats again on the strong, I guess, inaugural quarter reporting with the group results and thanks again for your commentary.

[Operator Instructions] We have no further questions. So that does conclude today's call. Thank you all for joining. You may now disconnect your lines.