Slate Grocery REIT

TSX:SGR.UN

Earnings Call Transcript

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Slate Grocery REIT First Quarter 2021 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to Braden Lyons, Investor Relations. Please go ahead.

[Braden Lyons, Analyst, Investor Relations]

Thank you, operator, and good morning, everyone. Welcome to the Q1 2021 conference call for Slate Grocery REIT. I'm joined this morning by David Dunn, Chief Executive Officer; and Andrew Agatep, Chief Financial Officer. Before getting started, I would like to remind participants that our discussion today may contain forward-looking statements. And therefore, we ask you to review the disclaimers regarding forward-looking statements as well as non-IFRS measures, both of which can be found in management's discussion and analysis. You can visit Slate Grocery REIT's website to access all of the REIT's financial disclosure, including our Q1 2021 investor update, which is available now. I will now hand over the call to David Dunn for opening remarks.

[David Dunn, Chief Executive Officer]

Thank you, Braden, and thank you to all the participants for joining the call this morning. I'd like to focus on 3 key factors that are positioning Slate Grocery REIT well to continue providing our investors with a strong total return investment. Number one, the durability of our cash flows and our actionable pipeline for continued net operating income growth. Number two, the critical role that the neighborhood grocery stores play in the cost-effective and timely fulfillment of the last mile of food logistics. And number three, the strong macroeconomic tailwinds in the United States. First, on the cash flow durability and growth. Following Slate Grocery REITS's record performance in 2020, including the best annual new and total leasing volumes since inception, our business continued to advance operationally in the first quarter of 2021. The REIT occupancy finished Q1 at 93.1%, 90 basis points higher than pre-pandemic levels, representing the fourth consecutive quarter of occupancy gains. We have over $2 million of committed base rents coming online in the next several quarters, which will further increase the REIT's near-term cash flow. Additionally, our new leasing pipeline is deep. Our team is working on more than 200,000 square feet of actionable new leases, a testament to the continued desirability of our portfolio and grocery-anchored real estate more broadly. I'd also like to highlight a few of the creative initiatives our team is working on to enhance our existing revenue streams. In January, we entered into an agreement with 5G LLC, who we will partner with to lease out our rooftops to telecom providers. Businesses like Verizon, AT&T and Amazon will then install antennas on our rooftops to enhance their 5G infrastructure across the United States. Perhaps the most compelling part of this opportunity is these long-term leases require 0 landlord capital. We can execute leases with multiple providers per property. Each deal will contribute 30,000 annually, and we expect the program will produce cash flow in 2022. We are also actively evaluating other opportunities to further drive revenue growth through rooftop solar panels, underutilized common areas, pop-up shops and seasonal installations. These attractive opportunities are available to us because our assets are both highly visible and well located within neighborhoods in close proximity to the end consumer. Second, on grocery fulfillment. Customer expectations are changing, and they are demanding access to their groceries faster than ever before. For example, Walmart is doing 1.5 million deliveries each and every week from their stores, which is 7x more than they were doing a year ago. In response, grocers are investing billions into automated fulfillment solutions. These investments are being made at or adjacent to their stores because the last mile is the most expensive component of the supply chain due to the cost of delivery and labor. So to be clear, despite an increase in online grocery shopping in the United States from 4% of total grocery sales pre-pandemic to 10% now, the majority of these online sales are still being fulfilled through the neighborhood store to minimize the time and cost associated with the last mile. Additionally, grocers are also investing in technology to incentivize the in-store shopping as this is where margins are the highest. A few examples of this are automated carts like the KroGo cart, mobile applications that allow customers to scan and pay for their groceries with their smartphone as well as automated kiosks to support in-store navigation. Collectively, the growing investment in both automated fulfillment and the in-store experience illustrate the integral role the neighborhood stores playing in the future of grocery. They make our tenant relationships stickier and ultimately increase the value of our real estate. Third, on macroeconomic growth. In stark contrast to what's currently happening in Canada, life is approaching pre-pandemic norms in the United States. The $5 trillion in government aid for both households and businesses, coupled with an impressively managed vaccine rollout, have combined to increase consumer confidence and spending in the United States, ultimately resulting in 3 straight quarters of robust economic growth. The consensus view among economists is GDP growth will pick up further in the second quarter and remain steady in the second half of the year. These supportive macroeconomic tailwinds bode well for our business and provide us with further confidence that demand for our grocery-anchored real estate will continue to be strong in the coming quarters. Finally, our strong operational performance throughout the pandemic enabled us to execute over $530 million of opportunistic and off-market acquisitions since June 2020. Our most recent acquisition of 25 properties, which we expect will close in early Q3, represents a unique opportunity to purchase $390 million of grocery-anchored real estate from a single transaction and highlights the value of the Slate Asset Management platform. 83% of the acquired portfolio's income is derived from the top 50 MSAs, including 46% from New York City and Dallas, 2 of the largest markets in America. We continue to be pleased with the performance of our business in what has been a unique and challenging operating environment. We are fortunate to have a fantastic team at Slate Grocery REIT that brings unwavering passion and commitment every day to add value for both our business and our unitholders. On behalf of the entire Slate Grocery REIT team, we wish you and yours good health. And we thank you for your continued support. I'll now hand it over for Q&A.

[Operator]

[Operator Instructions] Your first question comes from Li Chen with iA Capital Markets.

[Liyan Chen;iA Capital Markets;Analyst]

A couple of quick ones from me. So with the latest big acquisitions that's set to close in Q3 like you mentioned and with pro forma debt to GBV at around 61%, I was just wondering if you can comment as to what we can expect on your pipeline in terms of further acquisitions for the rest of the year? Or are you going to focus more on reducing your leverage?

[David Dunn, Chief Executive Officer]

Li, look, we've proven to be prudent capital allocators over what's been a challenging period. We have been able to buy $530 million worth of quality grocery-anchored real estate at a basis well below what we think market is today. That most recent portfolio acquisition was at $127 a square foot. We think there is value in this form of acquisition, buying it on a portfolio basis off-market. And when you contrast that with what we're seeing from a sentiment standpoint with marketed transactions in the marketplace, this real estate is undervalued. So we believe our debt to GBV, our LTV comes down once we acquire this and put it on our books and go through our fair value process like we do every quarter.

[Andrew Agatep, Chief Financial Officer]

One thing I wanted to add, just to give context what this deal is, this was something that we were negotiating in the second half of 2020. Think of the sentiment then around COVID-19, the elections and the vaccine rollout. There wasn't many transactions around that time. And when we think about it now, that pricing for that deal would be very different from today. Said another way, we acquired going in at a 7%, 8% cap. We think that there's value taking it inside to where we see our cap rate today, which is around 7% for our portfolio.

[Liyan Chen;iA Capital Markets;Analyst]

That's great. And just last one for me. Just regarding leasing spreads on new leases versus lease renewals. Going forward, do you believe this is the beginning of a return to a more usual trend that you're used to where the spread on your leases is considerably higher than on renewals?

[David Dunn, Chief Executive Officer]

I certainly do. I'll make a comment on spreads. We had a -- coming off of 4 quarters of record leasing, we did 1.7 million feet, which is 20% of our portfolio. There was just less leasing to do this quarter. We're -- we believe we're entering an environment now where spreads and rents are going to go up. It's something we're talking about with our team these days. We worked with tenants throughout the pandemic. We limited rent increases to help them through the tenants we thought we think are viable and will be around for the long haul. So we feel the environment is changing now to where we can push spreads. There are good tenants out there. The stimulus that's in -- the $5 million -- $5 billion of stimulus that's been injected from the Feds, the vaccine rollout in America is strong. And America is open for business, and tenants are doing well. So we feel like we're entering an environment where we can push spreads and bring them at or above sort of our historical run rate in that respect.

[Operator]

Your next question comes from Pammi Bir with RBC Capital Markets.

[Pammi Bir, Analyst]

Just looking at same-property NOI, it was down a bit. Same-property actually -- same-property occupancy, sorry, was actually up rather meaningfully on a year-over-year basis. Can you just maybe help us understand that disconnect? And then secondly, given the committed leasing that's coming online, should we anticipate some better growth through the year?

[David Dunn, Chief Executive Officer]

Pammi, thanks for the question. On a trailing 12-month basis, our same-property was positive, both with and without termination fees, 0.9% and 0.2%, respectively. So we've been successful with gaining traction and re-tenanting some of the premises that was vacated in 2020. So that might be a bit of a disconnect that you're referring to. But our momentum surrounding our portfolio at the moment is extremely strong. Coming off that record leasing, we have $2 million of committed base rent. These are contractual leases that will pay revenue that will be captured in our reporting in the next couple of quarters. And then when I look beyond that, we have a deep pipeline of new leasing opportunities. Our team has in excess of 200,000 square feet with quality credit tenants. On balance, the deals, they look like they're requiring less landlord capital. So net effective rents will be strong. And we think we can execute this new leasing pipeline, the majority of which leases should be signed in the next, call it, 4 to 6 months. So I'm thinking about filling a further pipeline of NOI growth beyond the $2 million of committed base rent that I just referenced.

[Pammi Bir, Analyst]

Got it. Yes, I was referring more so to the Q1 year-over-year, not the trailing 12 months in terms of same-property NOI. But I take it. Essentially, your commentary is suggesting that, given the leasing and the committed space, it sounds like it's -- it should be trending positively over the course of the year. Maybe just switching gears, looking at the portfolio write-up this quarter, you mentioned stronger demand for grocery-anchored retail. That's pushing cap rates lower. You guys have been able to source deals at comparatively better pricing. So I'm just curious, was the gain based on transactions that you're seeing in the market or at least the change in your cap rate assumptions or any other color you can share there?

[David Dunn, Chief Executive Officer]

I certainly can. I mean, desirability, sentiment for grocery real estate continues to increase and as a result, so are values. There's 2 reasons for that that we see. And as I referenced, just the visibility and resiliency and durability of the cash flow we've seen through the pandemic. Assets with a high percentage of grocery revenue and essential tenant revenues, such as our portfolio, where more than 67% of revenue comes from essential tenants. It's commanding a ton of interest.When you layer on the capital markets, understanding how grocers are going to deal with the surge in online shopping through their stores, automating, micro fulfillment, it's creating a strong tailwind. During the pandemic, there were limited trades to support value increases, but that's changed now. The floodgates are open whether you -- you're looking at one-off deals in a given market that we operate in or nationally in terms of M&A activity that we've seen, all supportive of strong values. I'll make one final point as well. This isn't only a North American dynamic. It's -- we're seeing it globally. Our team at Slate Asset Management is in the process of refinancing its grocery business in Germany. They're seeing extremely strong demand, a large number of debt partners are coming to the table. And it's producing very strong values as well. So we see this more broadly on a global standpoint. Capital is flowing into the last mile of essential logistics all over the world.

[Pammi Bir, Analyst]

Got it. And just thinking about the $390 million acquisition that you still have to close and your comments on, I guess, it being negotiated in the back half of last year, is there a possibility you may actually -- when you bring it on, look again, based on where you think it's -- what it might actually be worth once the transaction closes?

[David Dunn, Chief Executive Officer]

I think that's a fair assumption. We're going -- once we close, we'll go through the typical process, our fair value, rigorous discussion going through NOI, leasing assumptions, cap rates that are supportive of the values. And look, I'll come back to that comment. We bought this portfolio for $127 a foot. Half of the portfolio is located in Dallas, MSA and New York. That's not an entry point that you see very often into these -- the #1 and #4 markets in America. So it's fair to assume that there'll be some gains booked once we close this deal, but time will tell. And we'll go through the process likely in Q3.

[Pammi Bir, Analyst]

Okay. Just last one for me. Just on the rooftop antennas. As you roll out that program, I guess, possibly next year, what's the sense of the potential scope of that opportunity over the next, call it, 1 to 2 years?

[David Dunn, Chief Executive Officer]

I'm optimistic that it will produce some meaningful NOI growth and obviously, NAV growth. Telco budgets were just approved in March of this year. The team internally that's running this process think there'll be a strong take up. It will take a bit of time. That's why I'm a little cautious on guiding towards when NOI will flow. But I want to make it clear. So there are half dozen telecom providers, some traditional, some nontraditional, such as Google and Facebook. We can do multiple antennas on each roof. So you can produce $30,000 a year, times 2, times 3, times 4, depending on your number of service providers. So you can do the math like if we can get a take-up of 10% or 15% in the first year, get a multiple of 2 or 3 providers. I think it can produce hundreds of thousands of dollars of income for 0 capital, but it's just a matter of exactly when that happens. But what we're doing now with ancillary revenue is we're being smarter. We're partnering with people who can take this portfolio wide. We've tried ancillary revenue in the past with our team. It's hard to talk multi-market with these folks. So we're -- we think we found the right partner. They're excited, and they think it will produce some returns. We're just going to have to be a little bit patient.

[Operator]

Your next question comes from Himanshu Gupta with Scotiabank.

[Himanshu Gupta, Analyst]

So just from rent collection, how is it trending in the month of April and May so far? And with vaccination roll out much ahead in the U.S., so are you starting to see an uptick in rent collection as you get to reopening and as we see more vaccination roll out?

[Andrew Agatep, Chief Financial Officer]

Himanshu, it's Andrew. Collections continue to trend positively around 96%. We're seeing even a slight uptick in collection since the start of pandemic. We're averaging now around 97%. So it's very close to pre-pandemic levels. Just to give context, our operations in the U.S. is very different from what we're seeing in Canada. Most of our tenants, practically 99%, close to 100%, has been opened since August. Another way to think about that is with our deferral program. Strategically, we entered into $1.3 million of deferrals in the early Q2 of last year. We are now 96% through that program, and we have close to $42,000, which is a drop in the bucket of what we need to collect on in the remaining, let's say, 2 quarters. So I would say the sentiment in U.S. in operations, it's different. It's performing well, and we expect cash collections to continue 96% and plus.

[Himanshu Gupta, Analyst]

Got it. And then maybe can you comment on the leasing environment, specifically with respect to the small shop tenants? I mean, what are you seeing there over the next 6 to 12 months? As the stimulus program winds down or slows down, do you see any impact on your tenants? And any big leasing coming due in near term?

[David Dunn, Chief Executive Officer]

Himanshu, nice to hear from you today. Generally speaking, in the market, it's -- tenant activity is strong. We're seeing it in all different tenant uses and classes, but 2 key themes are coming through right now. It's number one, essential tenants, who have performed well during the pandemic. They're taking advantage of opportunities to add scale and presence in growth markets and in the right asset, like there are availabilities coming up for lease just by virtue of the turnover through the pandemic. So we're seeing tenants such as do-it-yourself, tool companies, pet shops, medical tenants, et cetera, taking advantage. We did 2 deals with essential tenants this quarter to backfill recently vacated junior box. The next trend is unique. And I think it speaks to just the rebound of the U.S. economy. We're seeing restauranteurs, both big and small, take advantage of second-generation restaurant infrastructure that's been recently vacated. You can save $100 a foot if you find a second-gen restaurant. And I think they're making a move now because of the government stimulus. People are going out for dinner more. People are spending this money on -- at their discretion. OpenTable came out last week and said their seated dining has returned based on their -- their data has returned to pre-pandemic levels. And retail spending was 9.8% up quarter-over-quarter last quarter. So people are getting out and spending. And I think entrepreneurs and quick-serve restaurants of the national variety are taking advantage. So we're seeing strong leasing velocity across the spectrum.

[Himanshu Gupta, Analyst]

Got it. That's helpful. And maybe last question on valuation. Obviously, you adjusted your IFRS cap rate down to 7%. So my question is, how is the appetite for portfolio transactions in the market today? I mean, in the past, over the few years, we have seen private local capital being available for one-off assets. So is it the appetite returning for portfolio transaction as well?

[David Dunn, Chief Executive Officer]

I think it's fair to say, yes, there's an appetite for portfolio transactions. We were able to do 3 of them in the last 9 or 10 months. All of them were off-market and of the opportunistic variety. We're probably not going to see screaming deals like we have seen, especially the $90 million acquisition we made last year. I think the cat is out of the bag in that respect. But what I'll say is when you do creative deals, it attracts other market participants who want to do creative deals. So we're getting inbounds from a variety of our peers in America that want to do business with Slate Grocery REIT and Slate Asset Management. So we continue to be active looking at opportunities, and we're going to -- as I said earlier, we're going to allocate capital as prudently as possible. So if I can get a double-digit return on spending money organically to grow maybe my redevelopment pipeline or to lease-up space in our portfolio, we'll look at that as well as we'll look at future growth opportunities via acquisition, if they're compelling.

[Operator]

[Operator Instructions] Your next question comes from Sumayya Syed with CIBC.

[Sumayya Syed Hussain, Associate]

Just a more follow-up on the fair value discussion and, I guess, potential moves post the quarter. David, do you see your cap rates moving even lower and specifically reflecting the recent large M&A transaction?

[David Dunn, Chief Executive Officer]

So at this point in time, we're happy with where cap rates are. They've come in commensurate with market demand and values over the last 6 months. With that said, we feel there's a lot of leasing we're doing. There's a lot of improvement of our merchandising within our shopping centers with credit tenants.And when we continue to execute on our leasing strategy, we retenant some of the vacancies that we're tracking to. I referenced 200,000 square feet of quality new leasing opportunities, I would expect that cap rates could potentially continue to come in. Again, we're only 4-plus months into 2021. Investment activity is strong. There's definitely a catch-up coming from sort of the muted activity in 2020. And all that we've seen so far, they're supportive of the fact that our portfolio was undervalued in the past and it's coming back in line. So overall, the market is strong, and we plan on continuing to take advantage of the opportunities while we can.

[Sumayya Syed Hussain, Associate]

Right. And then in the pending portfolio acquisition, is there any low-hanging fruit you could address in the near-term as you work the assets towards stabilization? And then what do you expect for overall time lines to get that portfolio fully stabilized?

[David Dunn, Chief Executive Officer]

I think there is. I think there is a lot of opportunity. We've been meeting with our joint venture partners over the last couple of weeks, getting to know them, integrating sort of our approach and our data with theirs. They are saying the same things that I am saying on this call about velocity of leasing and quality of tenants. The portfolio we bought was only 90% occupied. We did not underwrite any material occupancy gains until Year 3. And I can tell you that in aggregate, our 3 JV partners have about 150,000 square feet of leases they're working on right now to likely be signed in and around when we close. And all of that would be considered "gravy to our underwriting." So when we looked at approximately 4% accretion at underwriting, we have -- and we still have to get these deals done obviously. But we have some reason to be optimistic that we can exceed that as we get in and work shoulder to shoulder with our new partners to take it to the next level.

[Sumayya Syed Hussain, Associate]

Okay. So 3 years could be on the conservative side?

[David Dunn, Chief Executive Officer]

I suggest so.

[Sumayya Syed Hussain, Associate]

Okay. And you also spoke about, I guess, the evolution of micro fulfillment centers. Are any of your tenants exploring, incorporating this model in any of your assets?

[David Dunn, Chief Executive Officer]

That's a great question. So the answer is yes. I mean, the ones that are leading the charts are Walmart and Kroger and Ahold Delhaize. So that's Food Lion banner and Giant banner. The CEO of Walmart came out in February as part of their Investor Day and said, they're going to spend about $15 billion to start scaling. They call it local fulfillment, could be otherwise known as micro fulfillment. They're going to start in Benton, close to their head office and in their major markets, gateways and then move towards us. But what I'll note Sumayya is already today, 98% of our anchors are providing omnichannel solutions regardless of this automation. So they are providing delivery service from their stores and Click & Collect, obviously, from their stores. So it's already there. They'll just add a bit more of a technological enhancement in time. So yes, we think it's coming to our assets in time as well.

[Operator]

There are no further questions get up at this time. I'll turn the call back over to Braden Lyons.

[Braden Lyons, Analyst, Investor Relations]

Thank you, everyone, for joining the Q1 2021 conference call for Slate Grocery REIT. Have a great day.

[Operator]

This concludes today's conference call. You may now disconnect.