Cominar Real Estate Investment Trust's (CMLEF) CEO Michel Dallaire on Q2 2014 Results - Earnings Call Transcript

| About: Cominar Real (CMLEF)

Cominar Real Estate Investment Trust (OTC:CMLEF) Q2 2014 Results Earnings Conference Call August 7, 2014 11:00 AM ET

Executives

Michel Dallaire - President, Chief Executive Officer, Non- Independent Trustee

Gilles Hamel - Chief Financial Officer, Executive Vice President

Sylvain Cossette - Chief Operating Officer, Executive Vice President

Todd Bechard - Executive Vice President, Atlantic Provinces

Analysts

Jonathan Kelcher - TD Securities

Michael Smith - RBC Capital Markets

Matt Kornack - National Bank Financial

Heather Kirk - BMO Capital Markets

Pammi Bir - Scotia Capital

Operator

Good morning, ladies and gentlemen, and welcome to Cominar's second quarter results conference call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions are provided at that time for you to queue up for a question. (Operator Instructions). I would now like to remind everyone that this call is being recorded on Thursday, August 7, 2014.

I will turn it over to your host now, Michel Dallaire. Please go ahead, sir.

Michel Dallaire

Thank you. Good morning and welcome to today's conference call where we will be discussing Cominar's result for the second quarter ended June 30, 2014. The presentation for this call has being posted in both English and French in the conference call section of our website.

Inline with our disclosure principles, access to this call is open to the financial community and investors, the general public and the media. However, the question period will only be open to financial analysts and investors. Before we begin I would like to draw everyone's attention and to the material concerning forward-looking statements on page two of the presentation.

With me today to discuss our financial result is Gilles Hamel, our CFO. Sylvain Cossette, Guy Charron, Todd Bechard, Alain Dallaire and Michel Paquet, are also present with us. Gilles will discuss our financial result in detail in a few minutes.

But now let's discuss the highlights for the second quarter of 2014. As you can see on page three, our quarterly NOI and the same property portfolio NOI increased by 7.4% and 0.8%. Our recurring distributable income rose 7.4% and our recurring distributable income per unit amounted to $0.41, up 5.1%. Our financial situation remains sound and strong and as our debt ratio, excluding convertible debentures, stood at 50.9% at quarter end.

As you can see on page four, for 2014 to-date we completed $358 million of equity acquisition in our three asset segments with approximately 75% of the NOI coming from the GTA. These acquisitions were concluded at an excellent weighted average capitalization rate of 7%. Increased our real estate portfolio by 2.5 million square feet and have enhanced our geographic diversification.

Moving to page five. We are working towards the completion of Phase 5 of Place Laval, which is fully leased to a government agency. This project is on budget and will be delivered in the last quarter of this year.

On page six. At quarter end, our overall occupancy rate increased to 93.9% compared to 93.1% as at March 31, 2014. Over the first six months of 2014, we renewed 49.67% of our 2014 lease maturity at an average net rent that increased by 3% overall. We also signed new leases for a total leasable area of 1.2 million square feet.

Thanks to these excellent results, we have achieved our objective of reducing our DI payout ratio below our 9% target. And today we are pleased to announce that we will be increasing our monthly distributions to $0.1225 commencing with our upcoming September 15 distribution.

I will now ask Gilles to discuss our financial results in further detail.

Gilles Hamel

Thank you, Michel, and good morning, everyone. On page seven, you will note that our operating revenues for the quarter were up 7% reaching $179.7 million and our net operating income was up 7.4%, reaching $98.5 million reflecting the contribution of the accretive acquisition we completed towards the end of 2013 and during the first six months of 2014.

Recurring distributable income increased by 7.4%, reaching $52.1 million and recurring distributable income per unit totaled $0.41, up 5.1% or $0.02 compared to the second quarter of 2013. Distributions to unitholders totaled $46.7 million, up 2.4% from the second quarter of 2013, per unit distribution was $0.36 for both second quarter of 2013 and 2014. At quarter end, our recurring DI payout ratio stood at 87.8%.

Recurring FFO rose 10.1% and recurring FFO per unit on a fully diluted basis stood at $0.47 for the second quarter of 2014, an increase of $0.04 from second quarter of 2013.

Recurring AFFO reached $51.2 million, up 7.1% from the second quarter of 2013. Recurring AFFO per unit on a fully diluted basis stood at $0.40 for second quarter of 2014 which is an increase of 5.3% from second quarter of 2013.

Moving on to page eight. For the quarter, our total NOI increased by 7.4% and our same property portfolio NOI increased by 0.8% compared to the second quarter of 2013. This improvement is mainly due to the overall occupancy rate increasing from 93.4% as at June 30, 2013 to 93.9% as at June 30, 2014. We are maintaining our previously revised same property NOI growth expectation of 1.25% for 2014.

On page nine, you will find a summary of our financing activities. As of quarter end, our ratio of senior unsecured debts to total debt stood at 34.4%, up from 32.4% as at year-end 2013. As at quarter end, our weighted average interest rate on total debt was 4.69% compared to 4.76% as at December 31, 2013, a reduction of 7 basis points. Our annualized interest coverage ratio stood at 2.70:1.

Moving on to page 10. You will find details on our financial situation. At quarter end, total assets were valued at $6.5 billion and mortgages payable totaled $1.9 billion after the proportionate consolidation method. We also wish to highlight that earlier this week we closed $350 million unsecured credit facility. This new facility replaces our prior $300 million secured credit facility and provides borrowing availability based, among other things, on Cominar maintaining unencumbered aggregate assets in the amount of not less than 130% of the aggregate principal amount of its senior unsecured indebtedness outstanding. Our unencumbered aggregate assets currently stand at $2.3 billion representing 160% of aggregate principal amount of senior unsecured indebtedness outstanding.

With this completes our financial overview. I now turn the mic over to Michel.

Michel Dallaire

Thank you, Gilles. In summary, our financial result shows steady growth. Our recurring distributable income per unit is up by 5.1%. We have increased our distribution in our annualized DI payout ratio is back on our target of 90%.

Thank you for participating in this call. I will now turn the mic over to the operator for question period.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from Jonathan Kelcher of TD Securities. Please go ahead.

Jonathan Kelcher - TD Securities

Thanks. Good morning.

Michel Dallaire

Good morning.

Gilles Hamel

Good morning.

Jonathan Kelcher - TD Securities

Congrats on the good quarter and the distribution increase. Just turning right away to the leasing markets. You guys have achieved the highest overall occupancy that we have seen over the last, at least, four or five years. Can you maybe give us some color on the leasing markets? Where you are seeing the most strength? Are you still worried about the Montreal office market?

Michel Dallaire

Yes. In Montreal, we are seeing a lot of demand and presently, as I mentioned in the previous quarter, we are in discussions for about 1.5 million square feet of demand for new spaces and 27% of that demand comes from the office sector. Individual, as we completed so far this year, in the office sector, in Montreal, it's the place where we record a reduction in the net rent. The renewed net rent is about 3.7% lower than the early net rent. So we continue to manage with an aggressive policy of renewal leasing in the office sector in Montreal. But at the same time, we have been able to increase our occupancy. And it's the same thing in the Ottawa market since we decided to increase our aggressive policy of leasing in the Ottawa market based on the announcement of the federal government and we have tried to maintain the occupancy level at higher cost for us. So in some cases, we reduced the net rent at the renewal time. But the demand is there for the, and just back on Montreal, the industrial sector, on 1.5 million square feet of demand, 62% of that demand comes from the industrial sector also, in Montreal.

Jonathan Kelcher - TD Securities

Okay. So do you think your occupancy will be higher by year-end than it is now?

Michel Dallaire

Yes, I believe it is going to be higher. We are experiencing a lot of demand in Montreal and also in Quebec. And we have many deals that are under negotiation and we expect to increase the occupancy by the end of the year a little bit.

Jonathan Kelcher - TD Securities

Okay, and just secondly, turning to development. I guess you are basically done with Place Laval complex now. Would we expect, just from an accounting point of view, full rent to be paid on that beginning in Q4? Or will some of that be in Q3? Or how should we look at that?

Gilles Hamel

The delivery is expected to be at the end of Q3, beginning of Q4. So the impact on our revenue and our line will be mostly in Q4.

Jonathan Kelcher - TD Securities

Okay, that's fair enough. And now that you have done that, are there any other development opportunities that you are looking at over the near-term?

Michel Dallaire

We presently are at the point of -- we started with smaller industrial property in Quebec. We are working on a project in Calgary that will talk about the most confused about we have not Calgary that Sylvain will talk about the Mountain View development we have in Calgary, that we are waiting for the permits from the City of Calgary.

Sylvain Cossette

Yes, Jonathan, on that, in Calgary we are in all likelihood going to file the construction plans for the building permit in about a week to 10 days. And we should be engaging in terms of a development timeline for the Mountain View project and we will come back to you probably in the next quarter with a timeline for the development phase. That will be more of a 2015 to mid-2016 project.

Michel Dallaire

We are also working with the City of Ottawa for an office property of about 100,000 square feet for which we are in discussion with them. It's the process of obtaining the permit with them. So maybe it could probably start by the end of 2015, so another 10 to 12 months before we will have the approvals from the city.

Jonathan Kelcher - TD Securities

Okay. That sounds good. Thanks. I will turn it back.

Michel Dallaire

Thank you.

Operator

Thank you. Your next question comes from Michael Smith from RBC Capital Markets. Please go ahead.

Michael Smith - RBC Capital Markets

Thank you and good morning.

Michel Dallaire

Good morning.

Michael Smith - RBC Capital Markets

So my question is, with the distribution increase, is it fair to assume that you have increased the distribution because you have a positive outlook for results for the balance of this year and next?

Michel Dallaire

Yes, definitely. Michael, since the last recession where our payout ratio up 96% and we worked on bringing back below our 90% target. We are there and with the increase our expectations is, with the increase our payout ratio will be below $0.89 and we are expecting to -- we are going to start again to work to manage our distribution and our target as long as the payout ratio will be below 90%, the increase in DI per unit, we will supply the increase in the distribution over time.

Michael Smith - RBC Capital Markets

Okay. Thank you. And then, second question, can you discuss your pipeline, your acquisition pipeline and what you are thinking there?

Todd Bechard

Todd here. The pipeline is a little quiet. There's activity quite all over the place. We figure that for the rest of the year, we have about $40 million that we would do acquisitions.

Michael Smith - RBC Capital Markets

Okay, and then, last question. I guess you have got 3% rental bumps on renewals. Do you except that number to stay the same or increase for the balance of the year?

Michel Dallaire

We will expect to, for 2014, our guess it would be between the 3.25% and 3.5%. As I mentioned earlier, the office sector in Montreal and Ottawa bring down the overall average increase to 3%, but honestly 2014, I am targeting to be roughly at 3.5% by the end of the year for the 2014 renewal.

Michael Smith - RBC Capital Markets

For the overall average rent?

Michel Dallaire

Yes.

Michael Smith - RBC Capital Markets

Thank you.

Michel Dallaire

You are welcome.

Operator

Thank you. Your next It question comes from Matt Kornack of National Bank Financial. Please go ahead.

Matt Kornack - National Bank Financial

Good morning, guys. Can you just quickly provide the segmented SP-NOI numbers for each of the asset classes?

Gilles Hamel

Yes, of course, Matt. So we started with an increase of 0.8% for the same portfolio NOI and a breakdown of this amount by asset class is plus 2.4% for the office sector, plus 0.4% for the retail sector and minus 2.6% for the industrial sector.

Matt Kornack - National Bank Financial

And just a quick follow-up on the industrial, because you had mentioned some strength there. What was driving the negative 2.6% there?

Gilles Hamel

Well, this decrease represents only $400,000. It's a small amount, a small decrease. $400,000 and is purely factual. It's a comparison of one quarter to another quarter. The important point in the industrial sector, the occupancy rate increased from 93% at Q2 2013 to 93.9% at Q2 2014 in the industrial sector. And we renewed leases with growth in the average net rent of 3.4% in that sector and globally sequentially Q1 2014, our same portfolio NOI growth was negative by 2.4% and during Q2 2014 we realized a very strong reversal and our same property NOI growth is now plus 0.8%.

Matt Kornack - National Bank Financial

Right and so on industrial, it sounds like it may have just been a timing issue more than anything in terms of that negative segment growth.

Gilles Hamel

Yes, the amount is so small that it's for purely a comparison in time, because the strength and the flow [ph] of the industrial sector is very good.

Matt Kornack - National Bank Financial

And just going back to the capital side of things from an acquisition and disposition standpoint. Are you looking at any select dispositions within the portfolio? Or at this point, you are hoping to maintain the existing properties?

Sylvain Cossette

Matt, it's Sylvain. For the time being, we intend to maintain our portfolio as is.

Matt Kornack - National Bank Financial

Okay and just a quick accounting question. Straight-line rent was a bit higher for this quarter compared to Q1. Is that related to new leasing that's been put in place? Or can we read anything else into that?

Sylvain Cossette

As you know, straight-line rent revenue may vary from one quarter to another quarter. And that's true, this quarter, the straight-line assessment was slightly higher than in prior quarter but the six month our cumulative straight-line renewed at $2.3 million after six months. It is right on budget. And it is very comparable to prior year. So its just not sequentially always steady.

Matt Kornack - National Bank Financial

Sure. Thanks guys, and congrats on the quarter.

Operator

Thank you. Your next question comes from Heather Kirk of BMO Capital Markets. Please go ahead.

Heather Kirk - BMO Capital Markets

Hi. Just in terms of the investment in mortgage receivable, it seems to be tied to a related party and to a development. Can you just give us some color on exactly what that entails?

Michel Dallaire

Yes, Heather. Sylvain Cossette will answer that question.

Sylvain Cossette

Good morning, Heather. The receivable relates to a development project that we maybe exploring for 2015 onwards. It's a parcel of land which is adjacent to the Complexe Jules Dallaire. We refer those as owned, the parcel which is right next to the Complexe. It's a project which has the potential for approximately 370,000 square feet of commercial and office and 275,000 square feet approximately of residential, which is comprised basically of 200 units. So that's a development project which we would be looking at down the road.

Heather Kirk - BMO Capital Markets

So is that something that would be sort of similarly structured to the Complexe where it would be with the family, taking out the residential?

Sylvain Cossette

Yes, correct. Currently that is absolutely correct. Currently the lot needs to be divided to carve out the residential component and the REIT tax rules don't really allows or provides for us to purchase that inventory land. So it was best for us to participate at a later stage in the project. And there is also the municipal approvals which need to be obtained in order to remove the residential component. So we are at that early stage of structuring it and yes, the Groupe Dallaire would be our partner in that project once the project is set up to allow us to proceed with a commercial development.

Heather Kirk - BMO Capital Markets

And you know, a couple of years ago, you had made a statement that you were looking to get away a little bit from development unless it was sort of pre-leased and one-off. I am just wondering what your thoughts are in the current context and whether there's been any change to that view?

Sylvain Cossette

The answer is no. But we think by doing this project in a partnership with the Groupe Dallaire that allows us to comfortably manage that risk. So we will, traditionally, we are going to Montreal for example on development. We have a pre-leasing target. And we previously mentioned, in Quebec, the occupancies, in terms of average occupancies are smaller and people don't necessarily commit months or year ahead of time. So there is a reality in Quebec which is different. A project like this would have a two to three year development cycle and if you compare to the Complexe, the Complexe currently has 95% occupancy, and the absorption in this neighborhood is probably around 250,000 square feet per annum. So it is something we feel comfortable with. And we believe this is a very good opportunity in partnership for us with Groupe Dallaire and allows us to mitigate that risk.

Heather Kirk - BMO Capital Markets

Okay and just a final question. You made a bit of an unprecedented change to your debt covenants for your existing bondholders. I am assuming that's in an attempt to see your spreads come in but if you could just walk us through the rationale for offering that up?

Gilles Hamel

The rationale for offering, well first of all, I think just to highlight our strategy with respect to the management of that side of our balance sheet. We had basically committed that we would three things in our discussions with bondholders and we are happy that we are delivering on them and including our discussions with DBRS, we always mentioned that we strive to maintain our level of unsecured debts to total debt close to 50%. At the commencement of the year, we were 32% and we are after the conversion of the secured lines to an unsecured line, we are at 40%. So we are on track. As we repay mortgages, we will be on track to achieve that 50% target.

The second key component for us was geographic diversification which we have improved as a result of our 2013 to-date acquisitions in the GTA. And in context with increasing or penetrating more of the unsecured debt market to broaden the bandwidth of investors that will invest in your paper, it was important and it required for us to get the covenant. And yes, we fully expect that it will help us achieve and drive spread compression. So that's the backdrop of that.

Heather Kirk - BMO Capital Markets

Do you have a sense of how much that might tighten in? Or --

Gilles Hamel

At the current time, no. But we are hoping to be significantly rewarded for our efforts.

Heather Kirk - BMO Capital Markets

Great. Thanks very much.

Operator

Thank you. Your next question comes from Lewis Baker, a private investor. Please go ahead.

Gilles Hamel

I apologize. We could not hear the question on the mic. Hello.

Operator

The participant has removed himself from the queue. I will proceed with the next question. Pammi Bir from Scotia capital.

Pammi Bir - Scotia Capital

Thanks and good morning. Just going back to the next potential phase of Complexe Jules Dallaire. Do you have a sense of the potential cost for the commercial component?

Sylvain Cossette

Well, it's in the size of $90 million.

Pammi Bir - Scotia Capital

And would that be split? Is the intention to split it than just 50/50 again with the family on that?

Sylvain Cossette

Yes. The family presently owns that one and the intention to split from day one at 50% with Cominar the development projects. So it means that Cominar 50% will participate in the value creation on that project.

Pammi Bir - Scotia Capital

Okay and have you, just certainly with 95% occupancy at CJD, it would seem that the interest in terms of pre-leasing, I know you typically maybe haven't done it that way but would it seem that the interest would be pretty strong?

Gilles Hamel

Basically at Quebec city, when we started the Phase 2 of Complexe Jules Dallaire, previously it was almost nothing. And we will probably be same thing with that project. So if it is possible to find pre-leasing of 15%, 20%, it is probably the maximum we are going to have to start the project. As I mentioned earlier, the average tenant in Quebec city is about 3,000 square feet. So those tenants, they will never commit to sign a lease three years in advance. I have been in the development of Quebec since 25 years and in Quebec city, we have to start the project, to show the project and the leased up will come through the construction phase. So the Complexe Jules Dallaire is presently in lease at 95% and the expectation is we are going to need about three years to do that development. And we will lease up the project during the construction, during those years.

Pammi Bir - Scotia Capital

Okay and then just maybe, it might be a little bit early, but any sense or initial indications of what the targeted yield would be?

Gilles Hamel

In the range of 7.5% cap rate and a project like this, the market value is roughly in the low 6%. It's not possible to buy a project like this. You have to build it in Quebec city.

Pammi Bir - Scotia Capital

Right. Okay and then just, I guess with the completion of Place Laval, should we expect, I guess you are, at least in the interim, your capitalized interest to fall off through the rest of this year and then I guess, maybe with this other project, or some of the other projects you mentioned, once they start we will start to see a tick back up again? Or can you give us some color around that?

Sylvain Cossette

Since the delivery date of Place Laval is expected to be end of Q3, beginning of Q4, so the capitalization of interest will continue until the delivery date. So you can expect that in Q4 there will be a reduction in the interest capitalization.

Pammi Bir - Scotia Capital

Okay and then, just last - sorry, go ahead? Not in Q3, okay.

Sylvain Cossette

Not in Q3, the interest capitalize in Q3 will be about the same as it has been in Q2.

Pammi Bir - Scotia Capital

Okay. All right. That's helpful. And then just lastly, going back to the industrial segment for a moment. It was down, but I guess for the balance of the year and given your guidance for keeping that 1.25% overall growth rate, should we expect that the growth in that segment to start to turn positive for the rest of this year? Or maybe towards the end?

Michel Dallaire

Well, we are experiencing a lot of demand in industrial in Montreal for new spaces. And effectively most of the demand are in the same portfolio. So as the occupancy will go up, I believe the same portfolio growth in the industrial sector will go up also.

Pammi Bir - Scotia Capital

Okay. Great. Thank you.

Michel Dallaire

You are welcome.

Operator

(Operator Instructions). You have a follow-up question from Heather Kirk of BMO Capital Markets. Please go ahead.

Heather Kirk - BMO Capital Markets

Hi, just one follow-up. In terms of the revitalization projects at Alexis Nihon, and Place Longueuil, you have signed some additional leases and I am just wondering what kind of NOI contribution you might have had in the quarter? Or whether that's further out that we should expect income to come on?

Todd Bechard

Yes, obviously. We are in the last phases, obviously, of redevelopment right now in these three major centers in the Greater Montreal Area. In Place Alexis Nihon, the great news is and we see great sales increase per square feet and in the mall overall. So, it's a step-by-step process, and it should increase of NOI of the property during the last quarter due to certain new tenants. So, it's a step-by-step process.

Heather Kirk - BMO Capital Markets

Okay. That's great. Thanks.

Operator

Thank you. There are no further questions at this point. You may proceed.

Michel Dallaire

Thank you. So once again, thank you, for taking time to participate in that conference call and we invite you to join us again in November for our Q3 results. Have a nice day.

Operator

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

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