RFA Financial Inc. (RFA) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Artis REIT's conference call to discuss the proposed spin-off of its retail portfolio and strategic debt-reduction initiatives. [Operator Instructions] Today's discussion may include forward-looking statements, which include statements that are not statements of historical fact and statements regarding Artis REIT's future financial performance and its execution of initiatives to deliver unitholder value, including the proposed transaction and initiatives disclosed in its news release issued today. Such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see Artis REIT's public filings for a discussion of these risk factors which are included in their annual and quarterly filings, which can be found on Artis REIT's website and on SEDAR. Thank you. And I would like to turn the meeting over to Mr. Armin Martens. Please go ahead, sir.

Well, thank you, moderator. Thank you, everyone, for joining us. Again, my name is Armin Martens, the CEO of Artis REIT. And with me on this call is Jim Green, our CFO; Jackie Koenig, SVP, Accounting; and Kim Riley, EVP of Investments. So this call is a supplemental call, if you will, to the press release that we issued this morning pertaining to the spin-off of our retail portfolio. And we do draw on your attention to an investor presentation pertaining specifically to this Retail Spin-Off that we've uploaded last night or first thing this morning as well. So in our website, you can follow the link and download this presentation, 14 or 15 pages. If you don't already have it, it's still worth downloading. But in any event, download it later and take a good walk through it. So then I'll begin. And bear with me. As I present, I'll be following this presentation. It won't take too long, and then we'll be opening the floor to questions. So again, in summary, what we're doing is -- so the press release told you a lot, but the background isn't very complicated. Artis is a diversified commercial REIT. We own 3 asset classes: office, industrial and retail. We really were primarily an office and industrial REIT: 83% office/industrial and 17% at retail. Our retail is open air -- primarily open air needs-based retail. Very good. We're performing well in terms of numbers, but we are caught in this chronic and structural vortex of diversified REIT trading [ gobble analysts' NAV ], never mind their own NAV. And we were not trading at one of the price multiples of the 3 asset classes that we own. And this is briefly demonstrated on Page 3 and the charts there. You see this time and time again. And after a while, it gets old. It becomes -- you realize after all, well, it's just actually structural, investors everywhere from Toronto to Red Deer, New York to London and Singapore. Institutional investors, in particular, wealth managers have made a decision to strongly prefer pure-play REITs. And that's -- so we're particularly -- today, we're announcing that we're taking a big step in that direction. And it's a twofold strategic initiative, if you will, but one we've already commenced with. And that's selling noncore properties to pay down debt, improve our balance sheet. We already have a very conservative payout ratio. We're working to make us -- give us and create a pristine balance sheet by paying down -- selling more properties, paying down more debt. We're grateful that we're getting good traction this year already and good traction already. We thought this might be lost year, but it's not a lost year at all in terms of some properties and paying down debt and again at prices that correspond to our values. And then of course, spinning off the retail to further unlock value, improve price multiples. We don't know if we're getting -- what value we're getting for our retail in our portfolio. Some people say little or no value. It's probably -- it might be negative value. It's better for our retail portfolio to be in a separate retail REIT. It's better for our investors, better for the portfolio, better for everybody involved. In one way or another, it will unlock value, and it will be easier for analysts and investors to assess, to analyze, to appreciate and put a value on. And as we move forward quarter-by-quarter, we think we'll be able to do a very good job with that retail REIT and have opportunities to grow. And we'll be able to have opportunity -- M&A opportunities as well on both sides of the ledger. And of course, it's good for Artis REIT, which will become -- the same quotation as a pure-play office and industrial REIT as pure play as we've ever been and that's better for Artis as well. Better for the [Audio Gap] of course, we think very good for our unitholders in terms of unlocking value. Moving on to Page 5. If you're following the booklet, we give you a glimpse of the new structure. More info on this will be in our information circular that comes out in mid-October. We don't need to discuss everything here. But you'll see there the diagram showing a pure-play retail REIT. And that holds the limited partnership that owns all the Canadian properties on the left side. Basically, we are making a slight tweak here. We're creating new LPs, pure play; pure, so to speak; play, so to speak; for the industrial -- for the office. And the U.S. will have pure-play sub-REITs that will hold the industrial property separately and the office property separately, again, making things more efficient and easier if there ever is any opportunity for M&A. Next, Page 6, we show you all the pie charts you can hope to see. On the left is where we are today as of Q2. It's always based on NOI. You can see that, again, we're 48% office, 35% industrial. So that's 83% office/industrial today at Q2 and retail only 17%. And at the bottom, we show you it's provinces and states we're in. Going to the right is where we would be pro forma with a snapshot as of Q2. And you see that Artis REIT will or is 58% office, 42% industrial post spin. And on the right -- and at the bottom, we see what states and provinces we're in. This means we'd be about 63% today invested in the U.S. and 37% in Canada. So it gets skewed more to the U.S. On the right side, you see the retail REIT. 100% retail on Western Canada as 3 Prairie Provinces. 92% open-air unenclosed malls, needs-based retail. We have one mall representing 8% of the retail NOI, and it is held for sale. We expect that one property, Regina, to be sold and that proceeds will be used to pay down debt and improve the balance sheet even more. In the bottom, you see where our breakdown by province in the 3 Prairie provinces. Now moving to the next slide. On Page 7, we'll give you -- next couple of slides, they're all about Artis REIT -- Artis REIT 2.0, if you will, the office/industrial REIT. You can see in the top tables what we own in Canada in terms of office portfolio. We break it down by asset class. Office in Canada, office in the United States by GLA, occupancy, WALT, book value, property NOI and the total. Same thing with industrial, Canada and the U.S. and then the totals at the bottom. And can see what the NOI was at Q2, and the breakdown again was close to 40% Canada and 60% in U.S. net [indiscernible]. The bottom is all about our tenant profile. Bottom 2 pie charts on the right, you see the office profile, our national tenants breakdown by national tenants, government, local and regional and then industrial. Same thing with industrial. As we move forward, we'll be able to become even more granular with the type of tenants we have in our asset class and our MD&A. So on the next page, 8, we highlight pro forma credit metrics for Artis REIT. And this won't -- we think we'll get there by the end of next year. So it's all about improvement, improving the REIT well. Our debt-to-GBV will improve down to 46%. EBIT interest coverage ratio will improve also up to 4.3%. Debt-to-EBITDA will move down to 8.4. Liquidity will improve. Our payout ratio we think will gravitate to 60%. Today, it's about 52%. So very good improvement on that front. It should be -- it's great for our investors, great for -- in our common all unitholders. Great for our preferred unitholders as well. On the last page in terms of the office/industrial REIT, the highlights. Our industrial portfolio does represent a healthy -- it's a healthy industrial portfolio with a strong growth profile. We've been averaging 5% same-property NOI growth over the past 10 years. We're in great markets on both sides of the border. We have a great history, a good track record in terms of our industrial and greenfield development. And we have continued to have very strong industrial development pipeline right now. So we really have a blue-chip, institutional-grade industrial portfolio in our portfolio right now, full stop. Our office portfolio has been improving nicely over the years as we've gotten past the Calgary office market and sold down our Calgary office portfolio. And it's stabilized nicely. Over the past [ 10 years ], it's actually given us an average of 1% same-property growth. That number would have been a lot higher if we haven't been so hijacked, if you will, by the Calgary office market. But today, that's -- the Calgary office market is behind us, and our growth profile is improving very nicely. So we like those 2 portfolios a lot. In terms of Artis REIT, spinning off the retail, it reduces that distraction -- it eliminates that distraction, and it reduces Artis' exposure to Alberta in general. And again, as I said, our credit profile improved. Now a bit about the retail REIT. Again, we think it's a win-win for both REITs. The retail REIT will be a smaller REIT. It's, of course, 40 properties, about 2.8 million square feet in the 3 Prairie provinces, largely unenclosed, open-air strip malls, needs-based, tenants defensive, if you will. As I said, we have got one enclosed mall that is held for sale. Value -- IFRS value today is about $780 million. Again, we think -- and we're in good markets, good neighborhoods with good underlying fundamentals to support these properties. The cash flow is positive, and it's designed to be successful. The balance sheet will be just fine and improving. Payout ratio will be low and it will be a cash flow-positive REIT. It will not be a REIT that's under stress looking for capital. On Page 11, you see the map of where we own our properties, also by city, not just by province. And then on the bottom right, you've seen the type of properties we own in terms of neighborhood centers, convenience centers and community centers. And then on Page 12, and I'm moving -- I think we're making good time here. It gives you another -- a different snapshot of our overview on the $780 million in total IFRS value. And NAV per unit is $2.55 on our book. So we're going to end up with a good balance sheet, a conservative payout ratio. Again, cash flow-positive. The balance sheet will be improving as we sell some properties, and we will, the balance sheet will improve. Now this REIT will be externally managed by Artis REIT, and we thought that's the right thing to do. We think right now on year 1, over time, in a perfect world, we want this retail REIT to grow and then the management team internalized. So we're keeping it simple and nobody has to guess what the G&A is or will be. It's 35 bps for an asset management fee, and it's 3% property management fee. And this is based in revenue-neutral that property management fee at breakeven. So that, frankly, to the end of that. I have 2 more slides, but the more -- another -- well you heard me talk at the beginning about valuations and sort of the rationale for spinning off into at least one pure-play REIT at a time. And you can see on Page 13, we give you pure multiple valuations. And we've just taken some peers in different assets -- peer REITs in different asset class: industrial, retail and office. And these are -- the lower the bottom of the pack, if you will, are the lowest price multiples. It doesn't mean they're not the best REITs, but they're at the bottom of the pack in terms of having lowest price multiple. So we're not comparing ourselves to the average of every REIT or the top half but really the bottom. So you look at the 2 industrial REITs, the average price multiple there is 15.3. You look at the 2 retail REITs at the bottom of the pack here, the average price multiple is 9.1. And then the bottom 3, we talk of office REITs, average price multiple is 9.2. Then you correspondingly multiply that against Artis' retail FFO of $0.23, office FFO of $0.66, industrial of $0.48. And you see in these COVID times, we're getting a price of $15.52 a valuation. Pre-COVID, the number would even be higher. If you want to take worst-case scenario, still take the lowest of all these, take the lowest trading -- retail REIT, lowest trading office REIT, lowest trading industrial REIT today, in these COVID times, you would get a price of $12.50 for Artis. So you can see our frustration. And when you compare that $12.50 and 5 -- $15.52 to our current price of $9, $9.50, at that rate, you can see that it doesn't take long after a while to come to a conclusion that it is time to take a step forward and possibly in a different direction and look at streamlining and undiversifying, if you will. But basically, that's all about unlocking value for our unitholders. There's an old saying the customer is always right. And if the investors want pure-play REITs, then that's the direction we have to go and so -- in order to deliver results and increase unitholder value. On the last Page 14, just a reminder of the transaction milestones. We've announced everything today is the day. The interim court order is expected to be in middle of October. The info circs will get mailed out middle of October as well. Unitholder vote, again, middle of November. And closing will be in Q1 next year as early as possible in the new year. That's our plan. And we're very pleased about this, very optimistic. And at this time, I'll ask the moderator to open the floor for questions.

[Operator Instructions] And your first question, sir, will be from Jonathan Kelcher at TD Securities.

First question, just on the assets held for sale of $550 million. Can you maybe give us a breakdown of what type of assets you're selling, maybe geography and how many office, industrial and retail?

I'll let Kim weigh in here. Primarily office and some retail. Maybe it's about half and half [indiscernible] the listing. And it's mostly Canada, but some United States. But Kim, can you give him more details?

Yes. No, that's a pretty good summary. It's mostly office. There's a couple of retail, and they are in a variety of markets kind of across Canada and the U.S.

Okay. And then so the -- I guess the stuff -- the 42 assets that you had at the end of Q2 and you have 40 assets in your presentation here, would that be -- would that include -- I guess it might be smaller if you're selling a bunch of retail assets?

Yes. Good catch. What is that? Go ahead, Kim?

Yes. So there's one asset that will be -- that is kind of being held for sale. And then there's one asset that we're kind of reclassifying from Q2 to now. It's part of our Winnipeg office developments. We're calling it mixed use, so it will move and stay with the main REIT rather than the retail REIT.

The Delta Shoppers Mall?

The Delta Shoppers is the one that's held for sale, and then 330 Main is the other one that we just completed development up.

Okay. So when this spins out, given what you've got listed with brokers and assuming everything sells, how many assets do you think will -- how many properties do you think will be in there?

In the retail? It will come down. It could either come down by another 5 properties, and it could come down by anywhere from another $60 million to $100 million. And again, all of that -- all those proceeds will be used to pay down debt and you get our debt closer to 48%, 47% on the retail side.

Okay. So that would reduce debt at the pro forma Artis, and the retail REIT is going to have slightly higher debt. Is that the way to think about it?

No. That would reduce debt on the retail side. I guess it will depend when we get it done.

Right now, the plan is to put those 40 assets as if they were going into the retail REIT. And if some of them sell pre-closing, then retail would spin out with less than attached to it.

Next question will be from Matt Logan at RBC Capital Markets.

Just following up on Jonathan's question with regards to leverage. If we look at the target leverage, as it stands without any asset sales, that's about 54% for Artis Retail REIT. And when we compare that to the Q2 balance sheet, it would seem that you plan to place roughly $200 million on the retail portfolio before spinning it out?

That's correct.

How hard is it going to be for you guys to place mortgage debt on these assets? And have you had any discussions with the banks or other financing options to date?

So we have some of them in the market right now. We've actually got, I would say, 3 really good proposals in on 3 different assets. So far, it's going really well. And then -- and we'll likely have a line of credit available for the retail entity that will form part of the debt.

That's great color there. And what sort of a rate would you guys be looking at for new debt on the retail assets today?

The only one I have a sort of firm proposal on today for new debt is a 5-year term interest rate in the mid-2.5% range.

And changing gears in terms of the planned spinout, could you give us some color on why you chose to do a planned spinout just for retail? I mean why not do all 3? And could we see 3 independent entities over the course of time?

Yes. So this is something we can do. Now we feel we've got good control of it. We -- execution, we think, is close to 100% in terms of spinning off the retail. If we waited -- if we wanted to spin off all 3, we would have to sell more properties first to improve our balance sheet more. But -- so we're not quite there. And we didn't want to wait another year and wait for all the stars to align perfectly. We wanted to get -- do this spin-off now. And it's just as well. It's only -- across the world, it's more efficient to do 3 at the same time, instead of 2. But -- this is something we can do now, and it will be the right thing to do, take things a step in the right direction. And then looking forward, Matt, for our price multiple for Artis REIT, which will only industrial and office. If it doesn't improve, bring us to NAV, then as we sell down properties and improve that balance sheet, we'll definitely look at splitting those -- that REIT into 2 more REITs.

And you guys seem to have really good traction on your asset sale program. Can you talk about maybe just some of the feedback that you've had to date and if there's any indications to the contrary that you might not achieve your IFRS marks for any reason?

Yes. So we're grateful for the traction that we're getting in all fronts, and we've launched some listings. And I -- and we've got an office building in Denver that's listed. It's getting a lot of traction. We expect to have our office building in Hartford sold soon too on the U.S. side. In Winnipeg, we launched 2 office buildings for sale. We're getting a lot of traction, a lot of interest. We've -- we launched a listing for some of our Saskatchewan retail portfolio. And the bulk of it is our one enclosed mall, again, very good interest. There are 2 of those properties already under LOI. So we're seeing -- and we've got a large -- I mean we've got another $200 million almost under LOI right now, under contract, still conditional, in addition to the properties that I just mentioned. And so we're grateful for that. Because there was a time when we thought this was going to be a lost year, but it won't be a lost year. And especially U.S. side, we're seeing money come back. The debt markets have opened up very nicely. Debt is there. And along with debt, equity is there. The deals are being chased quite aggressively in the United States. And Canada is just getting there. I mean Jim gave you one example of a -- mortgage debt's there, and it's somewhat agnostic as to the asset class. Actually, the metrics are all working. We don't -- we never ask too much debt on any of our properties. On the equity side, that's -- it's a little shy still but coming back. Buyers are looking to place their money. I think by now, everybody knows that trillions of dollars has been printed and pumped into the global economy to North America, and that means that eventually REITs, interest rates come down, cap rates come down and assets will become rare. So we're glad to see that we're getting as much traction. I don't think we're the only ones. We're sensing that other people in the business, looking to sell are finding buyers. Anything else, Kim?

That's a pretty good summary. I mean we're happy to see everything come back. Definitely, the U.S. came back before Canada, but now it seems there's lots of appetite out there for deals. And we're getting them done so...

And suffice it to say that in aggregate, you still see your IFRS marks as fair on a post-pandemic basis?

Oh, yes. Lest we forget, yes, we're definitely hitting those numbers, and some below and some above. On average, based on what we've got on the LOI contract, now we're ahead.

Next question will be from Mike Markidis at Desjardins.

In no particular order here. Just building on Matt's question on the debt profile of the retail REIT. Jim, do you expect that Artis REIT, Artis 1.0, will have to provide any intercompany debt or loan guarantees to that entity?

That's still to be determined, but I suspect a number of those properties that are moving over with existing debt, [ Armin ], do have the Artis guarantee on it. And I can't tell you for sure whether we'll get that released prior to spin or whether it will transfer with the debt and then will just have to fall off at maturity of those mortgages. So yes, there is a possibility that there will be some of that existing debt that will retain the Artis covenant on it.

Okay. I mean I think you made some comments about the new structure being more efficient. And I guess some of the comments alluded to potentially spinning out or separating the office from industrial down the road. But I was just curious if this new structure, all else equal, would have helped in the strategic review that was completed earlier this year in terms of selling the entity.